Understanding the difference between margin and free margin is fundamental for anyone engaged in Forex trading. These concepts form the bedrock of risk management and dictate your trading capacity. This guide will break down what free margin is, how to calculate it, and why it's a critical metric for your trading success.
What is Margin Trading?
Margin, in trading, refers to the portion of your account equity that is set aside as collateral to open and maintain a position. It is not a fee or a transaction cost but rather a security deposit held by your broker. This system allows traders to control positions much larger than their actual account balance through leverage.
The amount of margin required is inversely related to the leverage provided by your broker. Higher leverage means a lower margin requirement for the same position size, and vice versa. Essentially, margin trading enables you to amplify your market exposure.
How to Calculate Margin
The formula to calculate the required margin for a trade is straightforward. You need to know the trade size (volume), the contract size for the currency pair, the current market price, and your broker's leverage.
Margin = (Trade Volume (lots) × Contract Size × Current Price) / Leverage
Let's consider a practical example. Suppose you want to buy one standard lot of EUR/USD. The current exchange rate is 1.1030, and your broker offers 1:100 leverage. A standard lot is typically 100,000 units of the base currency.
- Margin = (1 × 100,000 × 1.1030) / 100
- Margin = 110,300 / 100
- Margin = $1,103
Therefore, to open this position, your broker will reserve $1,103 of your account equity as margin. If your account balance is insufficient to cover this margin, you will not be able to open the trade. You can reduce the margin requirement by using higher leverage (e.g., 1:500) or by trading a smaller volume (e.g., a mini or micro lot). 👉 Explore more strategies for calculating your trading requirements
What is Free Margin?
Free margin is the amount of money in your trading account that is not currently being used as collateral for open positions. It represents the funds available to open new trades or that can be withdrawn. Think of it as your available buying power.
This metric is dynamic and fluctuates with the performance of your open positions. If you have no open trades, your free margin is equal to your account equity. However, as soon as you open a position, your free margin decreases by the amount of margin used for that trade.
Monitoring your free margin is a core component of risk management. If your free margin drops to zero, you will be unable to open any new positions. Allowing it to get too low increases the risk of a margin call.
How to Calculate Free Margin
The calculation for free margin is simple. It is your current account equity minus the total margin used for all open positions.
Free Margin = Equity – Used Margin
Let's build on the previous example. You have an account balance of $5,000. You open the one-lot EUR/USD trade, which requires $1,103 in margin.
- Free Margin = $5,000 - $1,103
- Free Margin = $3,897
This calculation assumes no other open positions. Your equity can change due to floating profits or losses on open trades. For a more accurate real-time figure, you must use your current equity, which is your balance plus or minus any unrealized P/L.
For instance, if your open trade is currently showing a profit of $100, your equity would be $5,100. The free margin would then be:
- Free Margin = $5,100 - $1,103
- Free Margin = $3,997
A Practical Example of Free Margin
Most trading platforms display these key metrics clearly in a terminal or dashboard window. You will typically see:
- Balance: The total amount of money in your account without considering open positions.
- Equity: Your balance plus or minus any unrealized profit/loss from open positions. This is your account's real-time value.
- Used Margin: The total amount of margin currently locked up in all open positions.
- Free Margin: The amount available to open new trades (Equity - Used Margin).
If you open a one-lot EUR/USD position with 1:200 leverage, your used margin might be $552. If your equity is $3,888, your free margin would be $3,336. This free margin can be used for additional trades.
Understanding Margin Level
Margin level is a crucial risk metric expressed as a percentage. It represents the ratio of your equity to your used margin.
Margin Level = (Equity / Used Margin) × 100%
Using the figures from the practical example above:
- Margin Level = ($3,888 / $552) × 100%
- Margin Level = 704%
A high margin level (e.g., above 500-1000%) indicates a healthy, low-risk account with plenty of free margin. A low margin level signals that your account is highly leveraged and at risk.
Margin Call and Stop Out Levels
Brokers set specific margin level thresholds to protect themselves and you from excessive losses.
- Margin Call: This is a warning notification from your broker, typically triggered when your margin level falls below a certain threshold (e.g., 100%). It alerts you that your equity is no longer sufficient to cover the required margin for your open positions. You need to either deposit more funds or close some positions to increase your margin level.
- Stop Out Level: This is a more critical threshold (e.g., 50% or 20%). If your margin level falls to this level, the broker will automatically start closing your losing positions, starting with the one with the largest unrealized loss, until your margin level is restored above the stop out level.
To avoid these scenarios, always maintain a healthy buffer of free margin and use stop-loss orders on every trade to manage potential losses.
Key Takeaways for Traders
A clear understanding of balance, equity, margin, and free margin is non-negotiable for successful trading.
- Margin is your collateral. It is the risk you have on the table.
- Free Margin is your safety buffer and opportunity fund. It determines your capacity to withstand drawdowns and seize new opportunities.
- Equity is your account's real-time value.
- Margin Level is your primary risk gauge. Monitor it constantly.
Managing these metrics effectively is the essence of risk management in leveraged trading.
Frequently Asked Questions
What happens if my free margin reaches zero?
If your free margin drops to zero, you will be unable to open any new positions. Your existing positions will remain open, but if they move further against you, pushing your equity down, you will likely face a margin call and eventually a stop out.
Can free margin be negative?
Generally, free margin itself does not go negative. However, if your open losses cause your equity to fall below your used margin, your margin level will drop below 100%, triggering a margin call. In extreme cases, you could end up with a negative balance if the market gaps and your losses exceed your account equity, though many brokers now offer negative balance protection.
How can I increase my free margin?
You can increase your free margin in three ways:
- Deposit more funds into your trading account.
- Close existing profitable positions to realize the gains and increase your equity.
- Close unprofitable positions to free up the used margin that was acting as collateral (though this realizes a loss).
What is a good free margin level?
There's no universal "good" level, as it depends on your risk tolerance and trading strategy. However, a conservative approach is to never use more than 10-15% of your equity as margin. This ensures you have ample free margin to withstand market volatility. A margin level above 500% is generally considered very safe.
How does leverage affect my free margin?
Higher leverage reduces the amount of margin required to open a position. This means that for the same trade size, using higher leverage will leave you with more free margin. However, this also amplifies your potential losses, increasing risk. It's a double-edged sword that must be used cautiously.
Is free margin the same as usable equity?
Yes, in most trading contexts, free margin and usable equity are synonymous. Both terms refer to the funds in your account that are not currently pledged as collateral and are available for trading or withdrawal.