What is Margin?
Margin is the capital required to open and maintain a position in forex. The capital required need not be the equivalent to your lot size.
For example, if you want to buy EUR/USD worth $100,000, you don’t need to put in $100,000 to take the position. Instead, the amount will be much lower, like around $3,000.
In other terms, we can relate margin as deposit or collateral to take a position in the market. However, we cannot relate it as fee or transaction fee.
Margin is a portion of your funds that the broker deducts from your account balance to open a position.
This portion of the money is locked up until the trade is open, and is freed/released once the position is closed.
Margin Requirement is simply the percentage of the “actual position size” or the “Notional Value.”
That is, if the Margin Requirement is 2%, then you will need only 2% of the position size to take a trade.
The margin requirement is not the same for all pairs. It usually varies from 0.25% to 10% or higher.
What is the Required margin?
Required Margin is the margin expressed in terms of a specific amount of your account’s currency. Required margin is also referred to as Deposit margin, Entry margin or Initial margin.
For example, if your margin requirement to trade $100,000 worth EUR/USD is 1%, then your Required Margin will turn to be $1,000.
How to calculate Required margin?
Calculating the required margin for a trade is quite simple. Mathematically, the amount of margin (required margin) is calculated as a product of the position size value (Notional value) and the margin requirement.
Required Margin = Notional Value x Margin Requirement
The above expression is applicable only when the account currency and the base currency are the same.
If the base currency and the account domination are different, you will have to multiply the obtained Required Margin with the exchange rate between the base currency and the account currency.
Putting it all together
Let’s say you have $10,000 in your margin account as balance and you want to buy one standard lot (100,000 units) of USD/JPY. Let us assume 2% of your account balance is required to open this position.
For this, let us determine the Notional Value, Margin Requirement, and the Required Margin.
Since the base currency is USD and the account domination is USD, the Notional Value will be $100,000. The margin requirement will be 2% because 2% of the account balance is required to open this position. And using these values, the required margin will turn out to be $2,000 ($100,000 x 2%).
So, when you open a position, this $2,000 will be taken off by the broker as margin. And when you close the trade, the complete amount will be returned back to you.
This does not end our discussion on margin trading yet. There are few more terminologies as well, which shall be explained in the following lessons.