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Margin

MarginIn forex trading, a required margin is also known as an initial, deposit, or entry margin.

What Is a Margin?

First, let’s define the term "margin". It is the amount of money that an investor borrows from a broker and has as collateral in their account. This money is used to purchase an investment. It is also the difference between the total value of securities held in an investor's account and the loan amount from the broker.

Using a broker's loan to buy securities - in other words, borrowing money - is often referred to as "buying on margin". You cannot buy on margin with a standard brokerage account - you need a special margin account. This account allows for borrowing more money than with a standard account. In the stock exchange, the required (initial) margin is the portion of a security's purchase price that an account holder must pay for with available cash in the account.

Using margin to buy securities is using the cash or securities in an account as collateral for a loan. Such a loan has a periodic interest rate that must be paid.

The investor leverages the borrowed money, and therefore both the losses and gains will grow as a result. Margin investing can be beneficial if the investor expects to earn a higher rate of return on the investment than what they are paying as interest on the loan. For instance, you have an initial margin requirement of 70% for your account and you want to buy $10,000 worth of securities. As a result, your margin will be $7,000, and you can borrow the remaining $3,000 from the broker. When margin is expressed as a specific amount of your account’s currency, this amount is known as the required margin (RM).

Margin in Forex Trading

In forex trading, an RM is an amount that you are spending on your part of the currency pair. It is a portion of your funds that your broker reserves from your account balance to keep your trade open and make sure that you can cover the potential loss of the trade. After the trade is closed, the margin is released back into your account and can be used again to open new trades.

Each open position has its own RM amount that needs to be locked up.

An RM cannot be greater than the account balance. It is calculated based on account leverage. The difference between the RM and the dollar amount of how many lots you traded is how much money you are using in leverage. The RM calculation depends on the price of the pair that you are trading as well as the lot size and leverage.

Let's assume that you have $10,000 in your account and would like to open a long USD/CAD micro lot (1,000 units) position with the standard requirement of 2%. As USD is the base currency, the notional value of the position is $1,000. The formula of the RM is then Notional Value x Margin Requirement, i.e. $1,000 x 0.2 = $200. An RM can then be used to calculate a free margin - the equity in your account that is not tied up in margin for current open positions.

Summary

A required margin is a deposit reserved by a broker from a margin account balance during the open trade. When the trade closes, the deposit is released back into the account to be used for new trades. In forex trading, the RM is calculated by multiplying the position's notional value by margin requirement.