Opening a trading account comes with a certain level of responsibility. Traders have to know the basics of market behavior, the functions of trading software, and plenty of terms and principles. Among all the terms, margin and free margin are those that can't be avoided. They can seem simple, but smart traders understand that the ratio of margin and free margin is an essential indicator and can greatly impact trading strategy.
The concept of free margin Forex is crucial for traders because the success of the strategy depends a lot on how you can trade with leverage. Utilizing broker's funds can be a great benefit but requires a deep understanding of the above-mentioned concepts. Below, you will learn what a free margin is and how to apply it to manage risks and get the maximum profit.
What is free margin?
What is free margin in Forex? Let's refer to the concept of leverage. A broker allocates additional funds that their clients can use for trading bigger amounts of assets. Only the most risk-averse players can trade without multiplying their deposits. The free margin definition arises from leverage. It is literally money that you can use for opening new positions.
Free margin is closely related to the margin. The first one is capital available for new trades, and the second is capital involved in current transactions. Both indicators are important because they give an understanding of used and free funds. Due to the market volatility, they are not constant, and traders should keep an eye on them.
In other words, the free margin in Forex determines our maneuverability on the market. If it reduces, we won’t have many opportunities to make new trades. Moreover, an extremely low free margin can lead to a margin call or even to a forced stop out. Below, you will see how to calculate this indicator and how to incorporate it into your trading plan.
Free margin on Forex: How does it work?
When traders open positions, they usually use a 50:1 or 100:1 leverage. For some pairs, it can reach 1000:1 or even more. All this helps you to trade a big sum with a relatively small deposit. But still, brokers block some small amount of the deposit to insure themselves against big losses. This amount is called the margin. A margin shows how much funds are used right now in open trades. You can't use this money as it is already involved.
But what does free margin mean in Forex? It is an amount that is free for use. It gives you a wiggle room so you can open new positions to adjust the situation if things are not going as you planned. Obviously, the bigger the free margin, the more maneuver you have. On the other side, the more free the margin is, the fewer funds you use, and, in fact, your deposit doesn’t generate a potential income.
The Role of Free Margin in Risk Management
Now that we answered what is free margin in Forex trading, let’s move to risk management. As we said above, a very low level of this indicator can lead to margin calls. That means that a broker would notify you and warn you about the possible closing of all trades. It can happen if your free margin drops to a zero or even goes negative. This scenario can happen if your equity becomes less than a margin. This will result in the inability to open new trades.
However, this is not the only risk of dropping free margin. The market can be unpredictable, and you can encounter profitable opportunities at any moment. But to catch them, you need a decent amount of free margin to open new trading positions. Thus, it is reasonable to always keep a free margin level over 50%. To prevent high risks and ensure safe trading, you can embrace the following tactics:
- Always have extra money to fund your account. Even though we set stop-loss orders and try to be profitable at any moment, the market is like a seesaw. One moment, it can bring a great opportunity, but another moment, a price movement can force us to open additional positions. If you have your insurance account, you can always top up your deposit if a free margin drops to a dangerous level.
- Diversify your portfolio. Your equity is not constant. It may grow if you have unrealized profits or drop down if there are potential losses. Smart diversification can reduce risks and help to keep a safe level of a free margin. Traders know this method as hedging. You can choose both liquid (and risky) assets and the most stable ones with lower profitability.
- Monitor your account frequently. Major changes can happen in the Forex market at any time. Four trading zones enable non-stop interaction between buyers and sellers. Under these circumstances, traders should consistently control their trades and funds. A free margin indicator gives you a brief overview of the situation. If it is bigger than before, you are okay, and you have more potential profits than losses. Otherwise, it is better to check your positions and take corrective actions.
Using Free Margin for Trading Decisions
This section continues and expands on the previous one. Risk management is one of the most important considerations when trading currencies. However, the goal is not to avoid losing but to gain a profit. A fee margin can help you with this goal. Here are tips that will help you make better decisions:
- Replenish the account when the ratio “margin vs free margin” drops down. This advice was also mentioned in the risk management section. Why is it so crucial? A low free margin indicates that you opened many positions or that you experience unrealized losses. The situation may change if, for example, the price curve changes its direction, but it is better to have some extra funds not to rely solely on the probability.
- Follow the trend if you see the free margin growth. If you opened a long position and your free margin has increased during the last few hours or days, you may consider opening new trades on the same trend. The fact is that your free margin has a positive correlation with equity, and the latter grows when your trades are successful.
- Sell a part of your assets if a margin call is probable. If you don’t have an opportunity to constantly top up your balance, you can close some positions and sell the assets. It will free up the part of your money, the used margin will be reduced, and a free margin will give you more maneuverability.
- Be patient. Sometimes, if the free margin level is not critical, and you’re confident in your trades, it is better to be patient. Depending on the time frame you choose for your work, you can wail a little longer even if your position is not profitable at some point. The situation may change as the market is volatile. Surely, the decision to wait or close a position depends on your strategy and risk tolerance. But a free margin gives you a clear image of the overall situation with your trades.
Impact of Leverage on Free Margin
Margin trading incorporates using the broker’s assets. It literally borrows you a significant amount of money that you can use for your operations. Trading on such conditions requires a special account that prescribes maximum leverage for your trades. Big leverage can increase your profits, but, at the same time, it implies certain risks.
The leverage has an inverse proportionality with a free margin. Thus, you need less free margin if you trade with a bigger ratio (500:1 or 1000:1). This is very important as you can open more trades and require less deposit for bigger operations.
Practical Tips for Managing Free Margin
Free margin meaning is simple, but to use it properly, you need knowledge and experience. Improve your performance with these simple tips:
- Learn to trade. Get the advantage of dozens of Forex educational resources over the Internet. Most of them explain how to apply free margin. Study the peculiarities of this indicator before betting real money.
- Start with a small deposit or a demo account. Many brokers allow you to begin your Forex journey without replenishing your balance. Develop your strategy and understand the preferable level of a free margin before risking large sums.
- Grasp your risk tolerance and consider the margin level. Thus, it is important to understand what is free margin level in Forex.
- Seek professional advice. If you are a beginner, the best Forex robots can be extremely useful for you.
Calculating Free Margin
Forex free margin calculation is not rocket science. You can do it with simple and intuitive formulas. Here are operations to perform:
1. Equity = Account Balance + Potential Profits (or Losses).
For example, you have a balance of 1,000 USD and an open position with a potential profit of 10 dollars. That means your equity is 1,010 USD.
2. Free Margin = Equity - Used Margin.
If you have used 300 dollars for current trades, the free margin will be 1,010 - 300 - 710 USD.
This calculation is usually performed automatically by the trading program at any given time.
The Bottom Line
In this article, we've answered what is margin and free margin in Forex. These concepts must be understood by every trader. Failing to do it may lead to margin calls and automatic closing of your trades. On the other hand, free margin can help you to make rational decisions and manage your risks. It provides maneuverability for action and gives a clear understanding of your account situation. Apply it to your actions and increase your profits!