Forex 101: How Does My Margin Account Work?

The Forex market offers great OPPORTUNITY for everyone.

trading opportunity

Why is that?

All Forex traders have the chance to access great sums of capital. Also Forex traders are able to access this capital without paying an arm and a leg for it… and without requesting for a loan at 10 different banks.

So just in case you were not trading Forex already, I am sure that I have your attention now. :)

Welcome to the world of Forex!

This is a place with unlimited potential for almost everyone. BUT obviously this opportunity and potential comes with very high risk – free lunches do NOT exist. :)

If you have the willingness to risk and at the same time are able to control the risk to decent levels (keep your trading capital in tact), then you will be best positioned to potentially capitalize on this opportunity.

HOW TO JOIN

To be able to participate in the Forex market, the Forex trader needs to deposit their own money at a broker. This money is called margin. With a margin account, the trader is able to capitalize on the opportunity and use leverage to their advantage by controlling a larger position than the amount they would otherwise be able to control with their invested capital.

The concept of leverage is simple: leverage is borrowed money, used to invest. So in fact it is a (short-term) loan (which is called leverage). This leverage allows Forex traders to access and borrow capital.

For instance a trader with a leverage of 10:1 is able to trade and act with $10,000 if their own deposit is $1,000. Change that leverage figure to 20:1 and the controllable trade capital is not $10k, but $20k.

In the stock market the maximum leverage apparently is 2:1, which compared to Forex in the U.S. (50:1) and Forex outside of the U.S. (100:1 or sometimes more) is very low. Read more in this article “Leverage: The Trader’s Best Bad Friend.”

Traders do not pay interest on the borrowed amount, but they do pay spreads, commission, and sometimes roll-over (if the trader keeps the trade “overnight”). The roll-over differs depending on the trader’s trade direction (long or short) and the interest rates of the underlying currencies.

MARGIN ACCOUNT CHOICES

Traders can only start trading with real money if they make a deposit to the margin account at the broker of their choice. Most brokers will ask for a minimum deposit for the margin account. How much the minimum is depends on the type of account.

  1. Standard account/lots: minimum trade size 100,000 units of currency
  2. Mini account/lots: minimum trade size 10,000 units of currency
  3. Micro account/lots: minimum trade size 1,000 units of currency
  4. Nano account/lots: minimum trade size 100 units of currency
  5. Unit account/lots: minimum trade size 1 unit of currency

A standard, mini and micro account type can be easily found at most brokers. A Nano and Unit account would be more difficult.

The bigger the trade size, the bigger the margin account needs to be. Micro account minimum deposits can be as low as $50-$100. For mini accounts the minimum balance could be $500; and for standards maybe a few thousand.

CHOOSING YOUR CAPITAL VS ACCOUNT

These are just general figures and each broker will specify their minimum deposit amount (your margin account) per account type.

However there is a difference between the minimum and your desired margin account level. Let’s review a hypothetical case.

A new Forex trader with the name WXY has the intent of depositing $500 in their margin account. If the broker would allow it, does it make sense to open up a standard trading account with $500?

The answer is …. NO.

Let us review why. When trading a standard account, the smallest possible position size is 1 standard lot.

  1. A standard lot means taking a $100,000 position while only using $500 of their own capital.
  2. This is actually a 200:1 leverage (100,000/500=200).
  3. Assuming that this broker allows for a 500:1 leverage, then the broker will set aside $200 (20% of 1% of $100,000) as margin during the trade, which means there is only $300 left on the account.
  4. Any small dip in the trade would have a high chance of wiping out the margin account and the broker would place a margin call and later a margin closeout.
  5. Nobody needs to be Einstein to realize that with $300 in the margin account remaining and the trade fluctuating at $10 a pip, the margin account would have very little chance of surviving.

With a $500 margin account it would be wise to choose a micro account (max mini). Or maybe even a nano account as this would allow for better position sizing.

USE FEAR TO AVOID FEAR

risk in trading

Of course it is always wise to choose a deposit which makes sense for you as a trader. If you fear losing too much of your margin account in trading, then you are probably placing too much money at stake. If that fear were to impact you during trading, then this will certainly have a negative influence and lead to a loss of trading capital.

A trader must risk margin capital that does not exceed the fear threshold. Traders should be able to write off the entire margin capital at a loss without emotional imbalance or stress, otherwise the trading performance will be negatively impacted.

Obviously this number does not have to remain the same. When a trader improves their track record and becomes more confident, the fear decreases which in turn means that a trader can increase the capital allocated to trading (if possible). This process should only happen once in a while (based on performance statistics reviewed quarterly or semi-annually).

All in all, the following items are crucial in avoiding a margin call:

  1. A trader limits their risk per trade and uses adequate risk management.
  2. A trader chooses an account type that matches their deposit / margin account.
  3. A trader chooses a high level of leverage (but without using it). Remember traders do not have to use the leverage offered by the broker. By controlling the position size traders can limit the risk to a small percentage of the account thereby staying clear of jeopardizing the margin account.

When using these rules, a trader can use their margin account to participate and capitalize on the OPPORTUNITY that the market offers within proper risk boundaries of their own psychology and account parameters.

How much leverage do you use? And how much of your total capital do you invest in trading capital / margin account?

Thanks for reading and sharing! Wish you Happy Trading!

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Chris is the head of the mentoring program and trading room at Winner's Edge Trading. He has a passion for technical analysis and helping Forex traders achieve their goals in trading. Chris has been trading for almost 10 years and is most fond of the Double Trend Trap (as a strategy), moving averages (as an indicator) and Fibonacci (as a tool).
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  • Chris

    Thank you Nathan! :) Some fundie insight never hurts! :)

  • NathanTucci

    Good stuff, Chris. Glad to get some important fundamental information out there for folks!