Margin and Leverage Guide, Terms and How To Use

There’s a reason why an increasing number of people are getting attracted to Forex trading. Some of these reasons include flexibility and the low capital that the market requires to open a trade. Although it is widely spread that Forex requires low capital, some traders are still quite confused about the definition of margin and leverage. But understanding the concept of these two is quite important to maximize profitability in the foreign exchange market.

What is Margin in Forex Trading?

Margin accounts let you borrow money from the broker to open more trading positions. This will open up more exposure to the market. In every position you open, there is a specific margin requirement. This margin requirement is the money that you need to put as collateral or deposit to open a trade. Most of the time, the margin is the percentage of the full amount of the trading position. For instance, the broker will ask you to pay a minimum 5% deposit or margin to open a trading account. By depositing a small amount as a percentage, this creates leverage or others call it gearing.

Terms used in Margin Trading

There are several terms that you mostly see when you use margin in trading. It is very important to understand these terms so you will know when to use them or whenever you encounter these words as you trade.

Initial Margin

Also called a deposit margin, this term refers to the minimum amount required to open a trading position. Since margin is just a percentage of the real amount of the position, whenever the market turns against you, this amount will not be sufficient to cover the losses. In this case, you also have to monitor the maintenance margin.

Maintenance Margin

Maintenance Margin helps to ensure that you still have enough capital that will help you keep your positions open. It will be enough to cover the running losses. The maintenance margin also represents the minimum balance that is required in your trading account.

Margin Call

In case the market moves against you and the current capital in your account will not be sufficient to cover the margin requirement, a margin call will be made by the broker into the trader. This happens when the account equity is right below the margin requirement of the broker.

When you receive a margin call, you will have to deposit an additional amount in your trading account. In case you fail to deposit additional margin, the broker will be forced to close the trading position.

Negative Balance Protection

Stop-loss orders and margin calls are sometimes not enough for traders to avoid getting too many losses in Forex trading. Excessive losses mostly happen when the market becomes less liquid or during times of excessive volatility accompanied by slippage and gaps. There are currently a lot of brokers who are actively offering negative balance protection. It is also mandatory for EU-regulated brokers to have this negative balance protection because it safeguards the traders from the effects of high volatility. This is the best way for traders to not experience negative balance and lose even their initial trading capital.