Hey, so I’m very new to forex, started learning from the very basic terms and I’m a little confused about free margin term. I just cannot understand how “free margin” means the amount available to open new positions.
So lets say I deposited $1000 and my account balance is $1000, lets consider that $1000 as two $500s. Using one of those $500, I bought €500 (Lets assume rate of EURUSD was 1 to keep things simple). My free margin is equal to $1000 (Equity) - $500 (Margin) = $500, once I open that position. I understand that. But, after a while, say, the price moves against me and I’m in a $100 loss. If I close that position, realize my loss, my free margin would be $900, I completely understand that aswell. But I don’t understand how my free margin (or the amount I have available to open new positions) should be equal to $400 while that position is open and has an unrealized loss of $100. I have another $500 that I set aside and haven’t touched from my $1000 deposit, therefore shouldn’t the maximum amount I have available to trade (or open new positions with) be $500 instead of $400? Why can’t I open a new position worth of $500 while I keep the other position open?
The question I’m asking might not make any sense at all to someone who’s experienced, but please try to put yourself in the shoes of someone who is just starting out and is very unfamiliar with everything. Please let me know if anything is unclear.
To keep it simple.
• You had $100, you want to buy an apple which cost $10 to sell afterwards.
• Upon buying the apple at the rate of $10, you left with $90 which means you could still buy 9 more apples with that. (Free margin)
• Assuming upon holding your apple, there was an increase in the price of apple due to fruit shortages which created huge demand for the fruit.
• Let’s say apple had an increase of 100% from its initial price to make its actual price now $20 right? Which means you having a $10 gain on your apple.
• $90 (Initial Margin) + $10 (Profit) = $100; meaning now you have $100 of free margin to buy some more apples.
• Now, let’s take it vice versa; Assuming upon buying your apple at $10 the government approved zero interest loan for apple farmers which created more room for apple farming leading to much supply which caused the price of apple to come down to $5
• Now the apple you bought ati $10 now cost $5
• $90 (Initial Margin) - $5 (Loss) = $85; meaning due to the $5 loss on the apple you’re holding, you now have $85 left of free margin to buy some more apples if you’re optimistic the price of apple would go up in December.
I’ve been reading about margin the entire day (have read babypip margin lesson plenty of times) and I’m still really confused haha, I’m sure it’s a very simple thing but I just can’t wrap my mind around it. I’m probably just overthinking. So yeah, I don’t have that $10 but the apple I bought with that $10 still has a value. I can sell it for $5, if it drops more I can sell it for $3, if it drops even more I can sell it for $1, until it has a value of $0 (which would mean my position is liquidated, if I’m not mistaking). But that $90 remaining is still intact and can be used to buy more apples, no? Wouldn’t this mean my free margin would drop to almost zero before being liquidated and once my position gets closed out, it’d go back to $90?
Here’s an excerpt from Babypip’s "Understanding How Margin Works"
• Margin is NOT a fee or a transaction cost.
• Margin is simply a portion of your funds that your forex broker sets aside from your account balance to keep your trade open and to ensure that you can cover the potential loss of the trade.
• This portion is “used” or “locked up” for the duration of the specific trade.
•Once the trade is closed, the margin is “freed” or “released” back into your account and can now be “usable” again… to open new trades.
Because your Margin is simply a portion of your funds that your forex broker sets aside from your account balance to keep your trade open and to ensure that you can cover the potential loss of the trade.
If you had more loss on that apple, it’ll be deducted from your unused money/unused Margin i.e the free Margin, until there’s no money left from your unused money to cover any loss anymore.
So many experienced traders on this forum Suyan! Ask your questions by creating a THREAD, you’ll get your answers delivered quickly; then choose what’s best for you.
Why is it being deducted from unused/free margin that has nothing to do with that apple? When I sell an apple, which I bought for $10, for $5, isn’t that loss of $5 deducted from the $10 and not the $90? I don’t know if deducted is the right word for this, but that loss of $5 is caused because of the apple. But why does it affect the amount of apples I can buy with the remaining $90? I bought an apple for $10 and have $90 remaining. I can sell the apple for any price, I can sell it for $5, I can sell it for $4, I can sell it for $3 and lets say I do sell it for $3 (because price of an apple dropped to $3), I can now buy $93 worth of apples after I sell it (close my position). But why before selling it, I can only buy $83 worth of apples and not $90. I’m not quite sure how to explain this.
Good. First, be familiar with this analytical/mathematical aspect of trading.
• Take Free Margin’s equation to be constant,
Free Margin = Equity - Used/Locked Margin
This equation is constant and can’t be change because it’s already proved.
Requote: "Why is Free Margin free & Used Margin Used?"
• Used Margin is the margin that’s “locked up” and can’t be used to open new positions. This margin is already being “used” reason for the named “Used Margin”.
Used Margin is the amount of money you needed to deposit to keep your trade open.
Hence, it’s Used because it has been Locked on a specific position to keep that position open.
• Free margin can be used to open more positions or cover the losses across the open positions. If your trades are making a profit, you will see an increase in your trading account’s free margin, likewise if they’re making losses.
They’re free because they are not Locked to any position.
I understand your confusion, and I’m happy to explain it. When you’re just starting out, forex can seem a bit intricate with all its terminologies and concepts. Let’s break it down:
Example: $1000 balance with $100 unrealized loss = $900 equity.
Free Margin = Equity - Used Margin.
Example: $900 equity with $500 used for an open position = $400 free margin.
Your confusion arises from viewing the unused $500 as separate from the unrealized loss. In forex, equity (which considers unrealized loss) determines your available funds. So, even if you haven’t touched the other $500, an unrealized loss affects your total available funds for new trades. Suggest you start School of Pipsology
Margin required to open a 1 Lot position of EURUSD
= ($100000 Euros ) / 200
= $500 Euros
Now base on the chart above, price level are making a series of Higher LOWs (HL)
and Higher Highs (HH), my trade view for EURUSD is bullish.
I go Long 1 Lot of EURUSD at the ENTRY PRICE of 1.05949
(going long means buying 1 lot or 100,000units of EURUSD).
I define SUPPORT level to be 1.05200 (or you could call it stop loss level)
I aim to hit TARGET level at 1.06445 (according to my predetermined 50% target projection)
So, when i open a 1 lot EURUSD, $500 Euros will be deducted from my account balance of $1000 Euros, leaving the remaining $500 Euros account balance to facilitate drawdown.
My ENTRY level is 1.05949
My SUPPORT level is 1.05200
My position size 1 Lot (1 lot means 100,000 units)
What does this mean?
If price were to go lower after my entry at 1.05949 and i were to cut loss at 1.05200,
how much losses would i have incurred?
Since the position size is 1 LOT,
Projected loss
= [ (100,000units) x 1.05949 ] - [ (100,000units) x 1.05200) ]
= 105949 - 105200
= 749
The losses incurred would be $749 Euros, but when i enter a 1 lot position, $500 Euros was already deducted from my account balance of $1000 balance to set aside and serve as margin requirement for opening a 1lot position of EURUSD. Thus, i only have $500 Euros remaining balance to facilitate drawdown. This means if price level goes lower after my entry, drawing down to my stoploss level would be inconsequential, as my 1lot position would be close out automatically by the broker when price hit 1.05449. Even before reaching my preset stoploss level at 1.05200 .
Price that broker automatically close out my position
= $105449 / 100,000units
= 1.05449
After the position is closed automatically by the broker, the initial $500 Euros that was set aside to serve as margin requirement would be released and returned back to your account balance.
At this point in time, you would be wondering WTF? Why did the broker closed out my position? I’m scammed by my broker!! I had $1000 Euros i should be able to sustained a drawdown of $749 Euros. Assuming price went down but didn’t hit your stoploss, makes a U-turn and proceed to hit your target. Most newbie, don’t understand that $500 was set aside a margin requirement to OPEN A POSITION and they only had $500 left to facilitate drawdown.
On hindsight, if you had open a 0.5 LOT (50,000units) position instead of 1 LOT
Projected loss
= [ (50,000units) x 1.05949 ] - [ (50,000units) x 1.05200) ]
= 52974 - 52600
= 374 Euros
So long price never reach the stoploss level at 1.05200, your remaining account balance of $500 would be enough to serve as drawdown balance for your 0.5 LOT of EURUSD long position.
It is said that experience teaches wisdom and I entirely agree with that.
To get a full understanding of what free margin is I suggest you do the following. Open a demo account with $1k. Place a few trades with 0.8 lot sizes one after the other and note the metrics at the bottom of your trading platform where it says “free margin” if you are on Mt4. After a time you will be unable to place anymore trades because all your margin has been used up…or in other words no more free margin is left.
