If
the terms leverage, margin and margin call bring
thoughts of uncertainty to mind, you are not alone.
It’s no wonder there is such a lack of understanding
of these terms and practical trading application of the
principles behind them as the brokers barely touch on
the meanings and give few examples. Yet, the lack of
knowledge with proper application will inevitably be the
Forex trader’s doom, resulting in overtrading and a
broker margin call to close losing positions.
To
understand how to be protected from a margin call, we
have to first understand the terms involved. Then we
will need to understand and calculate how much margin
the broker requires in our account to sustain the open
positions and the maximum our positions could possibly
draw down or move in the negative before closing at the
investor’s stop loss or creating a broker generated
margin call.
The
leverage available in Forex trading is one of main
attractions in trading this market.
Leveraged trading, or trading on margin, simply
means that you are not required to put up the full value
of the positions you trade.
There
are several reasons for the higher leverage that is
offered in the Forex market. On a daily basis, the
volatility of the major currencies is less than 1%. This
is much lower than an active stock, which can easily
have a 510% move in a single day. With leverage, you
can capture higher returns on a smaller market movement.
More importantly, leverage allows traders to increase
their buying power and utilize less capital to trade. Of
course, increasing leverage increases risk.
Leverage,
in essence, is a loan that is provided to an
investor by the broker that is handling his or her Forex
account. When an investor decides to invest in the Forex
market, he or she must first open up a margin account
with a broker. Usually, the amount of leverage provided is
either 50:1, 100:1 or 200:1, depending on the broker and
the size of the position the investor is trading.
Standard trading is done on 100,000 units of currency,
so for a trade of this size, the leverage provided is
usually 50:1 or 100:1. Leverage of 200:1 is usually
used for positions of 50,000 units or less.
Although
the ability to earn significant profits by using
leverage is substantial, leverage can also work
against investors. For example, if the currency
underlying one of your trades moves in the opposite
direction of what you believed would happen, leverage
will greatly amplify the potential losses.
Margin
is the aggregate amount of customer cash pledged against
the aggregate Open Positions. The margin pledged is a
function of Maximum Trading Leverage Ratio. The higher
the leverage, the lower the pledged Margin. The lower
the leverage, the higher the Margin needed to carry the
position.
Mathematically,
Margin = Open Position Amount /
Maximum Trading Leverage Ratio. For example, a
USD/CHF 100,000 USD position (one standard lot) at
Maximum Trading Leverage Ratio 50:1 will require pledged
Margin equal to 100,000/50 or $2,000.
The
Margin Used formula can also be stated as:
Account unit / leverage X # open lots X exchange
rate (use 1 if USD)
To
assist with the calculations use Patty’s Forex Margin
Calculator (examples shown below) which may be
downloaded at no charge from www.SecretsFromTheHeart.com.
The TakeProfit amount needs to be 0 when
calculating draw down. If you would like to know the
maximum distance the currency index might move before
closing at Take Profit, enter your Take Profit value as
well as the Stop Loss and Spread values, then click
Calculate. The number shown in Worst PiP Drawdown is a
total of Grid Spacing or Stop Loss + Take Profit +
Spread.
Account
Balance can also be a lower number than the actual
account balance. So if the investor wants to risk only a
certain dollar amount of their account, say 50%, they
would enter the lower dollar amount. Then, they would
experiment with the Total Lots and or Stop Loss values
to determine their limits.
When
using the Margin Calculator to calculate the Worst Total
Drawdown on a Grid type trading method, each lot level
would have to be entered separately, then totaled
manually, since the trades will likely not have the same
pip drawdown.
Note:
To calculate margins for currency pairs, where USD is
NOT the Base (First) Currency (e.g. EUR/USD, GBP/USD…)
and crosses (EUR/JPY, GBP/JPY…), the Counter
Currency amount is first converted into USD using the
average exchange rates.
Example:
Customer buys 1 lot of EUR/USD when the price is
1.4428 – 1.4430. The average exchange rate is
1.4429. Therefore, 100,000 EUR equals 144,290 USD
(100,000 X 1.4429). $144,290 / 50 Leverage Ratio =
$2,885.80 margin required.
Another way to calculate it is to calculate it as you
would for a USD base pair, then take the result and
multiply it times the Base exchange rate at the time
the open order is placed. So a 100,000 USD position at
Trading Leverage Ratio 50:1 will require pledged
Margin equal to 100,000/50 X 1.4429 or $2,000 X 1.4429
= $2,885.80 margin required.
When
calculating the margin required on a cross pair such as
EUR/JPY, the EUR is the Base currency so you will use
the EUR/USD exchange rates at the time the open position
is placed.
The
formula to calculate the margin required is as follows:
(Account
type unit / leverage amount) X # of open lots X exchange
rate( use 1 if USD is the Base) = margin required (which
will show as Margin Used on investor’s account).
Example:
Customer has a 200:1 leverage mini account and buys 2
mini lots (0.2) of EUR/JPY when the price is 163.47 –
163.50. The EUR/USD rate at the time of order execution
is 1.4646  1.4648. The average exchange rate of EUR/USD
is 1.4647.
10,000
/ 200 X 2 X
1.4647 = $146.47 margin required.
Margin
Call is
a demand for additional funds to be deposited in a
margin account to meet margin requirements because of
adverse exchange rate movements.
! In
Forex, due to the fast moving market, brokers don’t
issue this demand warning. If Account Equity
falls below
the Margin Used or the Margin Level % hits 100% or less,
the broker will close some or all of the open account
positions. Brokers
vary on their rules on a Margin Call. Be sure you
understand the rules for the broker you are using.
Some
brokers don’t do margin calls on demo accounts! Be
aware of this while testing. Also, if you are demo
trading, be sure the leverage is set as the same as you
will be trading in your live account to have more
accurate results.
Also, if the trader has both long and short open orders
on the same pair, some brokers (Interbank FX is one of
these) only count the total lots going one direction,
whichever direction is greater. So 15 lots short + 7
lots long would equal only 15 lots on calculating
margin, instead of 22.
The
margin deposit requirement may also be stated as a
percent, such as 1%. 1% on a Standard Account would be
$1,000 per 100,000 units. 1,000 / 100,000= 1/100 or
leverage at 100:1. Some brokers may show the leverage
numbers reversed, such as 1:100.
With
200:1 leverage the trader is required to deposit .5%
(half of 1%) or $500
(500/100,000 = 1/200 or 200:1 leverage);
with
500:1 leverage the trader is required to deposit .2%
(one fifth of 1%) or $200;
with
50:1 leverage the trader is required to deposit 2%,
$2,000;
with
5:1 leverage the trader is required to deposit 20%,
$20,000.
Calculating
the worst possible draw down:
Now
we can move on to calculating the worst possible draw
down, which would be shown on the investor’s account
as floating Profit/Loss.
Patty’s
Forex Margin Calculator does all this for you but here
is how the calculation is performed:
First
calculate the draw down risk per lot.
For
this, add the stop loss value plus the spread distance
to obtain the worst possible pip draw down.
Then
multiply the worst pip per lot draw down times the pip
value, which will be the dollar amount of risk per lot.
Now
multiply the dollar amount of risk per lot times the
number of lots we want to trade to arrive at worst total
draw down value.
This
final value subtracted from the account balance equals
the account equity.
See
previous sample graphics.
! Equity must be greater than Margin Used
or
Margin Level % greater than 100% to prevent a Margin Call.
!
Also
note, the Account Balance needs to be greater than
the Margin Used + Worst Total Drawdown (not
adding the
drawdown as a negative number) to prevent a
Margin Call.
Account
unit values:
Standard
Account Unit = 100,000
Mini
Account Unit = 10,000
Micro
Account Unit = 1,000
Calculation
Formulas:
Margin
Used = Account unit / leverage X # open lots X exchange
rate (use 1 if
USD)
Equity
= Margin Used + Free (Usable) Margin
Equity
= Balance + floating P/L (use Worst Total Drawdown in
calculating)
Balance
on the MT4 terminal window displays the total account
balance of closed
positions which = Equity  floating P/L (or Worst
Total Drawdown in calculating)
Margin
Level % =
(Equity / Margin Used) X 100
Free
Margin = Equity – Margin Used
Worst
Pip Drawdown = StopLoss( or Grid Spacing) + Spread
$
Risk Per Lot = Worst Pip Drawdown X Pip Value Per Lot
Worst
Total Drawdown = $ Risk Per Lot X Total Lots
Margin
Required Per Lot = Account type unit / Leverage X
Exchange Rate of
Base (use 1.0 if USD)
Total
Margin Used = Margin Required Per Lot X Totals Lots
It
makes sense that the more lots we have open the more
account margin we use so the drawdown must be less to
stay within our limit. And the opposite is also true, if
we open less lots, using less margin, the account can
sustain a greater drawdown. If this is unclear, go back
to the Margin Calculator and experiment with it some
more as this is critical that you understand this
principle.
Comparing
Leverage Levels:
Due to the way Paradise and
Trumpeter increase lot sizes as they trade, it is more
effective to use a higher leverage level to reduce the
Margin Used and allow for more trades to be placed and
greater drawdown limits. The recommended level is 200:1
or greater. Below are screen captures taken from my
leverage video which can be seen in its entirety at: Secrets
Leverage Video.
!
Reminder:
Adding the Total Margin Used + Worst Total Drawdown is
equal
to the account balance
required to sustain the positions.
This
document, along with Patty’s Forex Margin Calculator
may be downloaded
at no charge from www.SecretsFromTheHeart.com.
Last revised 04/12/09.
This information is offered for
educational purposes only, you are not being offered or
given financial advice of any kind. This document, as
well as the Forex Margin Calculator program, may be
modified or withdrawn at any time and without notice.
They are offered ‘as is’ without any warranties or
guarantees and are to be used entirely to your own risk
without recourse to the originator and distributor. They
are not to be copied, sold, shared or posted in any way
or place to be accessed by others without written
consent of Patty Kubitzki. Please direct people to www.SecretsFromTheHeart.com
to obtain a personal copy and direct inquires and abuse
to admin at secretsfromtheheart dot com. It is recommended that
each investor verify the information and formulas
provided for accuracy, prior to live trading on a funded
broker account. Use due diligence and never trade with
money you can’t afford to lose.
Margin Calculator Program
with above PDF available FREE in VIP Member Area.
