The term margin is used in different contexts in Forex trading. The information below summarizes the main ways in which the term ”margin” is used in Forex trading.
In Forex trading, margin can be defined as the amount of money required to place a trade. Contrary to popular belief, margin isn’t a fee. Margin is simply a way of ensuring forex traders have an adequate account balance in comparison to the size of their open trading position/s. It’s important to note that the amount of money a trader needs in their account to open a position depends on the size of their position as well as other factors i.e. the currency pair they are trading.
The term margin can also be used to refer to the margin account which is a special type of account that Forex traders open to be able to borrow money and increase their return on investment when trades are profitable. Forex trading accounts are margin accounts because they allow a trader to take trading positions that exceed the account balance. A margin account is operated by a Forex broker. Forex traders take loans that are equal to the amount of leverage they are taking on.
Before a forex trader can be able to place a trade, he/she must deposit money into their margin account. The amount a trader needs to deposit is dictated by the margin percentage agreed upon between a Forex trader and their broker or typically what we refer to as the leverage ratio.
For a standard account trading 100,000 currency units, the margin percentage offered by many brokers is usually 1% or 2% or simply 100:1 or 50:1 respectively in regards to leverage ratios. For a 1% margin percentage, a trader who wants to trade with $100,000 has to deposit $1,000 in their account. The remaining 99% of the money ($99,000) is provided by their Forex broker.
It is important to note that Forex traders don’t pay any interest directly on the amount they borrow. Traders may however incur some charges on rolled over trades i.e. trades which are held longer than a day. Traders can also incur interest rate charges on fluctuating rates. Such charges are however incurred by traders who have leveraged highly on huge positions.
Forex brokers use margin balance as collateral or security. If a forex trader opens a position which goes against him/her, the broker can initiate a margin call when the losses consume majority of the initial deposit/margin balance. Ideally, there is an amount of money that must remain in your account if a trade goes against you. A margin call happens when a Forex trader no longer has adequate margin balance to keep holding losses incurred by a losing trade. When a margin call is approaching, a trader can either deposit more money into their account or close a losing position/s.