We all speculate! Don’t kid yourself if you think otherwise. If you can get this basic element of truth, the central core of any business, you would have been many miles ahead of your peers. So let’s begin a basic understanding of margin and margin calls which are at the heart of a successful trading business.
A margin is like going to a T-shirt wholesaler in Chinatown and making a 10% deposit on 100 dozens of T-shirts to be sold at a sports parade because you anticipate a large crowd and a good sale will line your pocket with huge profit. You go to the parade expecting a fortune and hoping to make a few bucks on a 10% deposit with the T-shirt supplier. You’ve never really done this before but you’ve heard stories of other successful hawkers and street vendors.
Your only capital is the deposit you made with the supplier and a quick profit forecast turned ugly because of poor weather, vandals who damaged your goods or city seizure because you had no license to hawk your wares. In any case, you lost and did not make a profit but your supplier does not care. He calls for his balance and threatens to seize your building, damage your credit, something you need to be a viable businessman. Simplistic as this analogy is, in Forex trading things are no different. It follows the same logic I just referenced above. So what is a margin and margin calls?
WHAT IS MARGIN?
Margin is simply the deposit that your Forex broker asks you to put down in your trading account to enable you control a trading position. A lay man calls this collateral but in trading lingo, it is called margin. For instance you can control a $100,000 currency account with only $1,000 in form collateral known as margin. In this example you are simply leveraging your account by 100 to 1. All it means is that your $1 has a trading value of $100, a potential windfall. But Because you are highly leveraged, a deposit of $1,000 is advisable and recommended because a wild swing can knock you off and you’ll lose badly, prompting a margin call from your broker or forces you to close your position. The best seed capital should be $10,000 but not below $1,000 if you really want to achieve some kind of success.
WHAT IS MARGIN CALL?
What then is a margin call and how relevant is it to your trading success? This is where you have to pay good attention because it can break or make your trading business very rewarding once you understand margin calls and how to navigate it to your advantage. In your trading account dashboard, you’ll notice stuff like this: Balance, Equity, Used Margin and Usable Margin. For instance, let’s look at a trading account with an opening deposit of $1,000 balance.
Usable Margin always equals to Equity, minus Used Margin, meaning that Usable Margin = Equity minus Used Margin. So it’s the Equity, and NOT the Balance that determines the Usable Margin. This means that Equity also determines if or when a Margin Call is invoked.
Therefore if the Equity is greater than the Used Margin, no Margin Call will be triggered.
Equity > Used Margin = NO MARGIN CALL
But as soon as the Equity equals or dips below the Used Margin, the margin call will be placed.
Equity = < Used Margin = MARGIN CALL
For example if your margin requirement from your broker is 1% to buy 1 lot of EUR/USD, the following could be a reasonable scenario based on a hypothetical deposit of $1,000 account. Remember that I’ve always advocated opening your trading account with not less than than $1,000 because currency trading is very volatile and a poorly funded account will expose you to gigantic loss whereas a well funded account will enable you to maximize trading leverage with good upside swings.
With an Equity of $1,000 and a Used Margin of $100, your Usable Margin will remain $900 – remember that the margin requirement to trade this mini account is $100 per lot.
But should you liquidate your position, by that I mean sell it back at the price you bought it, your 1 lot of EUR/USD your Used Margin would go back to $0.00 and the Usable Margin would get back to $1,000. Meaning that your Equity remains unchanged at 1,000. So you did not lose!
But it could all have changed and a bit ugly if instead of liquidating the 1 lot, you got carried away and buy 7 more lots of EUR/USD for a grand total of 8 lots of EUR/USD. Your Equity will still be the same, but your Used Margin will be $800 because 8 lots at $100 margin per lot = $800 driving your Usable Margin to a mere $200. Of course this is crazy and untenable but with this insanely risky position you will make a killing, a huge profit if EUR/USD rises. But in this business it could equally swing the other way. The EUR/USD could fall instead of rising and wipe out all your trading account, driving you into RED.
Look at what could happen when EUR/USD falls.
As EUR/USD starts to dip and you are long 8 lots, you will surely see your Equity dip also with it. Your Used Margin now remains at $800. As soon as your equity drops below $800, you will get a Margin Call from your broker. This will force some or all of your 8 lots be closed immediately at the prevailing market price. If you bought all 8 lots at the same price, a Margin Call will be triggered with a simple swing of 10 pips working against you.
Yes, a simple 10 PIPS!
Holy Crap! The EUR/USD pair moves as much in a blink!
Remember that when EUR/USD goes up 1 pip, your equity increases. If it goes down 1 pip, your equity decreases as well. So a $200 Usable Margin could vanish in thin air, just before you say holy crap!
This is why to avoid receiving a MARGIN CALL you should fund your account well and avoid being a statistic. For more on this topic call your broker or click here for additional help.
It is very good to understand this topic very well because this is at the heart of all successful speculation, the driving force of making or losing money with trading. When you understand this topic and the act of successful speculating, it works like magic!
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I find your site articles quite educative. Must have taken you some good time and research to come up with such information. That you provide them free is highly commendable. Kudos
Thank you so much for visiting my blog and for your friendly comment. I am cobbling together a very simple A-Z formula on How To Really Start A Trading Business Without Tears. Trading is actually very simple because it's an activity we do everyday without even knowing it. It looks difficult because the guardians of this trade use a trading lingo to mask what is so simple to understand. You don't need to read tons of books to understand trading.
Watch for my up coming program designed to demystify trading and unmask how money is made in trading and who the money makers are. If people should know the power of speculation and the tricks of manipulators, they will think twice what they do with their time. Learning to trade is an everlasting skill.