The Basics of the Forex Market – Part 2

Today we’re going to continue our Forex Market Basics series by covering the next component, margin. If you didn’t catch our Part 1 article on order types, head over here and give it a read.

Ok… so margin. Any decent forex broker offers clients trading on margin and leverage these days, so let’s get stuck into the concept of margin and what it actually is.

First of all, it’s really not as complicated as it might seem, think of it kind of like collateral for taking a trade position. Beginner traders often think of margin as a transaction cost, but really, it’s just a part of your equity that is ‘held’ while your position is open.

Another way to think of it is like a home loan. For example, if you want to buy a $200,000 house (in Sydney? Yeah right!), the bank or lender will ask you for a 20% deposit, so $40,000. Now, this $40,000 is still your money, you’re just using it to buy a $200,000 house. Margin, when it comes to the Forex market, works exactly the same way. It’s a loan from your broker that you use to open a larger position, and in order to do that, the broker requires part of your trading equity, called margin.

Leverage Ratio Margin Requirements

1:1          100%
2:1          50%
10:1        10%
50:1        2%
100:1     1%
200:1     0.5%
400:1     0.25%

The table above shows how much margin is required for various leverage ratios. Different brokers and countries have different rules and offerings when it comes to leverage. As we’ve already established, the margin is typically a percentage of the position size that you want to open with leverage. So, if your Forex broker offers 1:20 leverage, the required margin would be 5$ (100/20), just like for 1:50 it is 2% (100/50).

And that, folks, is the basics of margin. Stay tuned for part three when we dive into leverage.