Leverage, Margin, Balance, Equity, Free Margin, Margin Call And Stop Out Level In Forex Trading

I always see so many traders who trade forex, but still don’t know what margin, leverage, balance, equity, free margin and margin level are.

Margin and leverage are two important terms that are usually hard for the forex traders to understand. It is very important to understand the meaning and the importance of margin, the way they are calculated, and the role of leverage in margin.

Leverage:

Leverage is a feature offered by the broker, to help the traders to trade larger amounts of securities by having a smaller account balance. For example, when your account leverage is 100:1, you can buy $100 by paying $1. Therefore, to buy $100,000 (one lot), you should pay only $1000 (this is just an example. I know nobody pays dollar to buy dollar.

Now you tell me please. How much you have to pay to buy 10 lots USD with an account that its leverage is 50:1 ?

That is right. You have to pay $20,000 to buy 10 lots or $1,000,000 USD:

$1,000,000 / 50 = $20,000

Leverage was so easy to understand, right? I had to explain it first, to become able to talk about the other term which is margin.

Margin:

Margin is calculated based on the leverage, but to understand the margin, lets forget about the leverage for now and assume that your account is not leveraged or indeed its leverage is 1:1 

Margin is the amount of the money that participates in a position or trade. Let’s say you have a $10,000 account and you want to buy €1,000 against USD. How much US dollars do you have to pay to buy €1,000?

EUR/USD rate is currently 1.4314. It means each Euro equals $1.4314. Therefore, to buy €1,000, you have to pay $1,431.40:

€1,000 = 1000 x $1.4314

Therefore:

€1,000 = $1,431.4

If you take a 1000 EUR/USD long position (you buy €1000 against USD), $1,431.4 from your $10,000 account has to participate in this position. When you set the volume to 0.01 lot (1000 unit) and then you click on the buy button, $1,431.4 from your account will be paid to buy 1000 Euro against USD. This $1,431.4 is called margin. Now, if you close your EUR/USD position, this $1,431.4 will be released and will be back to your account balance.

Now let’s assume that your account has a 100:1 leverage. To buy 1000 Euro against USD, you have to pay 1/100 or 0.01 of the money that you had to pay when your account was not leveraged. Therefore, to buy 1000 Euro against USD, you have to pay $14.31:

$1,431.4 / 100 = $14.31

Now, please tell me that if you take a one lot EUR/USD with an account with the leverage of 100:1, how much margin will participate in the trade?

One lot EUR/USD = 100,000 Euro against USD
EUR/USD rate: 1.4314 100,000 x 1.4314 = 143,140.00 Therefore: One lot EUR =$143,140.00
$10,000 – $50 = $10,050
(200,000 x 1.4300) / 100 = $2,860.00
$10,050 – $2,859.52 = $7,190.48
($10,050 / $2,859.52) x 100 = 351.46%

Leverage: 100:1

Margin = $143,140.00 / 100 = $1,431.40

Therefore, to have a one lot EUR/USD position with a 100:1 account, $1,431.40 margin is needed.

Balance:

When you have no open position, balance is the amount of the money you have in your account. For example, when you have a $5000 account and you have no open position, your account balance is $5000.

Equity:

Equity is your account balance plus the floating profit/loss of your open positions:

Equity = Balance + Floating Profit/Loss

When you have no open position, and so no floating profit/loss, then your account equity and balance are the same.

When you have some open positions and for example they are $1,500 in profit in total, then your account equity is your account balance plus $1,500. If your positions were $1,500 in loss, then your account equity would be your account balance minus $1,500.

Free Margin:

Free margin is the difference of your account equity and the open positions’ margin:

Free Margin = Equity – Margin

When you have no position, no money from your account is used as the margin. Therefore, all the money you have in your account is free. As long as you have no position, your account equity and free margin are the same as your account balance.

Let’s say you have a $10,000 account and you have some open positions with the total margin of $900 and your positions are $400 in profit. Therefore:

Equity = $10,000 + $400 = $10,400

Free Margin = $10,400 – $900 = $9,500

Margin Level:

Margin level is the ratio of equity to margin:

Margin Level = (Equity / Margin) x 100

Margin level is very important. Brokers use it to determine whether the traders can take any new positions or not. Different brokers have different limits for the margin level, but this limit is usually 100% with most of the brokers. This limit is called Margin Call Level. 100% margin call level means if your account margin level reaches 100%, you can still close your open positions, but you cannot take any new positions. Indeed, 100% margin call level happens when your account equity equals the margin. It happens when you have losing position/positions and the market keeps on going against you and when your account equity equals the margin, you will not be able to take any new positions anymore.

Let’s say you have a $10,000 account and you have a losing position with $1000 margin. If your position goes against you and it goes to a -$9000 loss, then the equity will be $1000 ($10,000 – $9,000), which equals the margin. Therefore, the margin level will be 100%. If the margin level reaches 100%, you will not be able to take any new positions, unless the market turns around and your equity becomes greater than the margin.

But what if the market keeps on going against you?

If the market keeps on going against you, the broker will have to close your losing positions. Different brokers have different limits for this too. This limit is called Stop Out Level. For example, when the stop out level is set to 5% by a broker, the platform starts closing your losing positions automatically if your margin level reaches 5%. It starts closing from the biggest losing position.

Usually, closing one losing position will take the margin level higher than 5%, because it will release the margin of that position, and so the total used margin will go lower and therefore the margin level will go higher. The system takes the margin level higher than 5% by closing the biggest losing position first. However, if your other losing positions keep on losing and the margin level reaches 5% again, the system will close another losing position.

Why the broker closes your positions when the margin level reaches the Stop Out Level?

The reason is that the broker can not allow you to lose more than the money you have deposited in your account. The market can keep on going against you forever and the broker can not pay for this continuous loss. It makes sense, doesn’t it?

Cancelled By the Dealer:

When you have some open positions and some pending orders at the same time, and the market wants to trigger one of your pending orders while you have no enough free margin in your account, that pending order will not be triggered or will become cancelled automatically. Those trader who don’t know what “cancelled by the dealer” is complain when they see that a pending order is cancelled or not triggered. They think that the broker had not been able to carry their orders, because their liquidity providers had no enough liquidity or because the broker is a bad broker. But the the truth is that your pending orders could not be triggered or were cancelled because you had no enough free margin in your account.

There is a margin check that tests for what the MT4 account margin level will be after the trade is open, and if it is within the acceptable limits, it lets the trade through. The threshold for measuring the post-trade margin ratio is set by the broker usually at 120%, meaning that the bridge will calculate what the used margin will be in the MT4 account after the new trade opens, and if the account equity is less than 120% of the post-trade used margin, the trade will fail margin check and will be automatically cancelled by the bridge MT4 dealer accounts. Of course different brokers can have different post-trade margin ratio setting, but it is usually 120%.

How to check your account balance, equity, margin and margin level?

You can see this information by checking the MT4 terminal. Open the MT4 and press Ctrl+T. The terminal will be opened and it shows your account balance, equity, margin, free margin and margin level.

This can be different in other platforms.

Balance will change only when you close the position. The profit/loss will be added/deducted to the initial balance and the new balance will be displayed.

Balance – Floating Profit/Loss = Equity

Margin = $2,859.52

Equity – Margin = Free Margin

(Equity / Margin) x 100 = Margin Level

OK 

I hope you are not confused. It is very easy to understand. You may need to read the above explanations for a few times to completely digest the terms I explained.

Briefly and in very simple words:

Leverage: Is the bonus you receive from the broker to become able to trade large amounts with having a small amount of money in your account. When the leverage is 100:1, it means you can trade 100 times more than the money you have in your account.

Margin: Is the money that will be placed and engaged in the positions that you take. For example, to buy $1000 with the leverage of 100:1, $10 from your account will be engaged in the position ($1000 / 100 = $10). You can not use this $10 to take any other positions, as long as the position is still open. If you close the position, the $10 margin will be released.

Balance: Is the total amount of the money you have in your account before taking any position. When you have an open position and its profit/loss goes up and down as the market moves, your account balance is still the same as it was before taking the position. If you close the position, the profit/loss of the position will be added/subtracted to your account balance and the new account balance will be displayed.

Equity: Equity is your account balance plus the floating profit/loss of your open positions. For example when you have an open position which is $500 in profit while your account balance is $5000, then your account equity is $5,500. If you close this position, the $500 profit will be added to your account balance and so your account balance will become $5,500. If it was a losing position with -$500 loss, then while it was opened, your account equity would be $4,500 and if you close it, $500 will be deducted from your account balance and so your account balance will be $4,500. When you have no open positions, your account equity will be the same as your account balance.

Free Margin: Free margin is the money that is not engaged in any trade and you can use it to take more positions. You remember what the margin was, right? Free margin is the difference of the equity and margin. At the above example, your position margin is $10. Lets say the equity is $1000. Therefore, your free margin will be $990 ($1000 – $10). If your open positions make money, the more they go to profit, the greater equity you will have, and so you will have more free margin.

Margin Level: Margin level is the ratio (%) of equity to margin. For example, when the equity is $1000 and the margin is also $1000, margin level will be $1000 / $1000 = 1 or in fact 100%. If the equity was $2000, then the margin level would be 200%.

Margin Call Level: Is the level that if your margin level goes below it, you will not be able to take any new position. Margin call level is determined by the broker. When it is set to 100%, you will not be able to take any new position if your margin level reaches 100%. When you have losing positions, your margin level goes down and becomes close to the margin call level. When you have winning positions, your margin level goes up.

Stop Out Level: Is the level that if your margin level goes below it, the system starts closing your losing positions. It will close the biggest losing position first. If this helps the margin level go above the stop out level, no more position will be closed. Then if your other losing positions keep on losing and the margin level goes below the stop out level again, the system closes another losing position which is the biggest one.

Thanks for your time and have a great day/night 

What is Margin Call & Stop Out level?

QUICK SUMMARY

"Margin Call" vs "Stop Out level"

When the broker says that Margin Call = 100%,
this means that Margin Call = 100% and Stop Out level = same 100% of the Required Margin

This means that once your Account Equity = Required margin x 100% 

You’ll get a Margin Call and immediately a Stop Out, where your trading positions will be closed forcibly (one by one starting from the least profitable and until the minimum margin requirement is met).

When a broker says that Margin Call = 30% and Stop Out level = 20%, 
this means that once your Account Equity = Required margin x 30%
you'll get a Margin Call in the form of a Warning.

And when your Account Equity = Required margin x 20%
your trades will be closed automatically starting form the least profitable one.

DETAILS

"Margin Call" vs "Stop Out level"

While some Forex brokers operate only with Margin Calls, others define separate Margin Calls and Stop Out levels.

What's the difference?

Margin Call is literally a Warning from a broker that your account has slipped past the required margin in %, and that there is not enough equity (floating profits - floating losses + unused balance) on the account to support your Open trades any further.

(Speaking of trades, definitely only the losing trades will drag your account equity down, but even if you haven't accepted the losses yet, at some point you might run out of money, because your floating losses count).

Stop Out level is also a certain required margin level in %, at which a trading platform will start to automatically close trading positions (starting from the least profitable position and until the margin level requirement is met) in order to prevent further account losses into the negative territory - below 0 USD.

How does it work with different brokers?

If you see in the trading conditions something like this:

Margin Call - 30%Stop Out level - 20%

This means that when your Account Equity becomes equal 30% of the Required Margin, you'll get a warning from a broker: it can be

either a highlight on your platform, or a certain message, or an email etc. saying that your equity is now insufficient to continue trading and maintaining currently active positions; and that means that you have to either think about closing some of them or add more funds to the account to meet the minimum margin requirements.

If you don't do so in a timely manner & the market still doesn't cut any slack to your losing trades, you'll be approaching the Stop Out level - at which the system [a trading platform] will perform an automated closure of your unprofitable trades starting from the least profitable and until the minimum margin requirements are met.

If you see in the trading conditions something like this:
Margin Call - 100%
No mentioning of a Stop Out level

This means that Margin Call = Stop Out level = 100% Required Margin
When your equity slips past 100% of the Required Margin, you'll get a Margin Call & the trades will be closed forcibly in the same manner described above (starting with the least profitable one). The Warning Stage here is omitted, BUT don't be overexcited about the opportunity to get a Warning first with the 2 staged process, because a broker keeps the right to close your trades without prior notice even if it's only a Margin Call "stage".

Formulas and Examples:

To calculate the margin requirement required for every open position:

Required Margin = (Market Quote for the pair * Lots) / Leverage.

Example: You want to open 0.1 (10 000 base currency) lots of EUR/USD at the current market quote of 1.3500 and with a leverage level of 1:400

Required Margin = (1.3500 * 10 000) / 400 = $33.75

In order to open & further keep such a trade, you'll need to have at least $33.75 of the available equity on the account.

If we open 2 x 0.1 lots, the Required Margin is doubled = $67.5 and so on. The more positions you open, the higher is the requirement to keep them in the market.

Account equity = available not used in trade funds + floating profits from still open trades - floating losses from still open trades

Margin Call = Account equity has become equal to Required margin.

Pros and cons of 100% Margin Call vs lower % Margin Calls & Stop Outs

Simply put:

(+) being stopped at 100% margin saves for traders significantly more money when the losses are inevitable;
(-) being stopped at 10% margin saves only a few dollars on the doomed account.

(-) having a 100% margin requirement means that the Margin Call is looming much closer
(+) having a low 10% margin requirement puts the risks of getting a Margin call further away

(+) 100% margin requirement does the final stage money management job for you, so you won't lose your last short if you don't have the skills yet to do the proper money management yourself

(-) 10% margin requirement requires a perfect understanding and managing of the own account equity and margins.

How to avoid Margin Calls & Stop Outs?

1.       Carefully choose the leverage. If you choose a lower leverage, make sure you have sufficient funds to open and maintain trades. If you choose a higher leverage, make sure you don't open more trades than you can handle with your account equity.

2.      Reduce your risks. Control how many lots are traded at one time. Watch your account statistics for Required and Available Margin.

3.       If in doubt about meanings of the numbers in your Account, read more educational topics about the subject.

4.      Place stops to protect your equity from significant losses.

5.      If in trouble and approaching a Margin Call point:
a) try changing your leverage to a higher one
b) add more funds to the account

c). close unprofitable trades before the platform does it for you

d). hedge those trades, IF you know how to get out of the hedged trades later (requires experience)

All these measure will delay the approaching of the Margin Call, BUT you would still need to manage your losing trades before they bring any more losses.