What is Margin Level?

What is Margin Level? Lesson No 35

Let’s discuss something significant in forex trading, the “Margin Level.” It’s similar to a percentage, indicating how much of your money you can spend for fresh trades. If your Margin Level is high, it suggests you have more funds available for trading. However, a low reading is not good news. It suggests you don’t have much money left for fresh transactions, and it may result in a Margin Call or a Stop Out, which we’ll go into in depth later. Understanding your margin level allows you to better manage your funds in FX trading.

How to Calculate Margin Level

Calculating Margin Level is not as difficult as it may appear. It is a simple formula.

Margin Level = (Equity/Used Margin) times 100%.

Your trading platform performs this calculation for you automatically and displays the Margin Level. If you have no transactions open, your Margin Level will be ZERO.

Understanding margin levels is essential in forex trading. Brokers use it to determine if you can open more positions. Each broker sets its own Margin Level limitations, however many maintain them at 100%.

What does this mean? You are not allowed to create new positions until your Equity is equal to or less than your Used Margin. If you wish to make new deals, you’ll have to close the ones that already exist. This helps in effective risk management when trading forex.

Example #1: Open a long USD/JPY position with one micro lot.

Assume that you have $1,000 in your account.

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Step 1: Calculate Required Margin

Assume you wish to go long on USD/JPY and open a position of one mini lot (10,000 units). Your trader established a margin requirement of 4%.

To determine how much margin you’ll need, consider this, Because USD is the base currency, this tiny lot is worth $10,000, also known as the Notional Value.

Required Margin = Notional Value x Margin Requirement

$400 = $10,000 x .04

To calculate the required margin, multiply the nominal value by the margin requirement $10,000 multiplied by 0.04 equals $400.

To open this position, you will need a margin of $400. Understanding these calculations allows you to handle your trading capital more effectively.


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Step 2: Calculate Used Margin

If we’ve only entered one transaction and no other trades are open, the Used Margin will equal the Required Margin.

Simply said, because we only have one open position, the margin necessary for maintaining it is the same as the margin required to open it in the first place.

This insight allows us to precisely track our trading finances.

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Step 3: Calculate Equity

Assume the price has shifted slightly in your favour, and your position is now trading at profitability. When your position’s Floating P/L (Profit/Loss) is $0, it indicates that you have yet to make a profit or loss.

Now, let us calculate the equity:

Equity is the sum of your account balance and Floating P/L.

If your Floating P/L is zero and you began with an account balance of, say, $1,000:

Equity = Account Balance + Floating P/L

= $1,000 + $0

= $1,000

So your equity remains at $1,000. Understanding your equity allows you to track the overall performance of your trading account.

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Step 4: Calculate Margin Level

The equity to used margin ratio, stated as a percentage, determines the margin level.

So, if you have $1,000 in equity and $400 in used margin:

Margin Level = (Equity / Used Margin) x 100%

Replacing the values gives us:

Margin Level = ($1,000 / $400) x 100%

= 2.5 x 100%

= 250%

As a result, the Margin Level is 250%. Understanding Margin Level allows you to determine the risk in your trading account.

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Think of the Margin Level like a traffic light.

Green Light: If the Margin Level exceeds 100%, it is equivalent to having a green light at an intersection. You are free to open new trades without restriction.

Red Light: However, if the Margin Level falls to 100% or lower, it is equivalent to hitting a red light. Most trading platforms will not allow you to open additional transactions if it appears that you do not have enough funds to cover possible losses.

In our case, a Margin Level of 250%, which is far higher than 100%, is equivalent to having a green light. You can still open new trades and manage your account. Understanding this concept is essential for successfully controlling your trading activities.

Recap

So, exactly is the margin level? It’s similar to a ratio that tells us how our Equity relates to the Used Margin and is expressed as a percentage.

For example, if you have $5,000 in equity and $1,000 in used margin, your margin level will be 500%.

Now, in our previous lessons, we have covered a lot:

We discussed margin trading, which is the use of borrowed money to trade.

We learned about balance, which refers to the amount of funds in your trading account.

What is the difference between unrealized and realised P/L? Understand how profits and losses affect your account balance.

What is the margin? The required margin is the amount of money set aside and “locked up” when opening a trade.

What is the Used Margin? Used Margin is the total amount of margin that is currently “locked up” in order to keep all open positions open.

What is equity? Equity is your balance plus the floating profit (or loss) on all active positions.

What is free margin? The free margin is the money that is not “locked up” as a result of an open position and can be utilised to start new positions.

Let’s move on to the concept of Margin Call Level.