In forex trading, leverage, margin, free margin, and equity are important concepts to understand, as they all relate to the amount of capital that a trader has available to trade with and the risks associated with trading.
- Leverage: Leverage allows traders to control larger positions in the market with a smaller amount of capital. It is a loan provided by the broker to the trader, which can magnify the potential profit or loss of a trade. For example, if a trader has a leverage of 1:100, they can control a position worth $100,000 with only $1,000 in their trading account.
- Margin: Margin is the amount of money that a trader needs to maintain in their trading account in order to keep their positions open. It is a percentage of the total value of the position, and it is determined by the leverage ratio. For example, if a trader has a leverage of 1:100, they need to maintain a margin of 1% of the position size to keep the trade open.
- Free Margin: Free margin is the amount of money that a trader has available to open new positions. It is calculated as the difference between the equity and the margin. For example, if a trader has a total equity of $10,000 and a margin of $2,000, their free margin would be $8,000.
- Equity: Equity is the current value of a trader’s account, taking into account all open positions, profits, and losses. It is calculated as the account balance plus or minus any unrealized profits or losses on open positions. For example, if a trader has an account balance of $10,000 and an open position that is currently losing $1,000, their equity would be $9,000.
It is important for traders to manage their leverage, margin, free margin, and equity effectively in order to control the risks associated with trading and to avoid margin calls or stop outs, which occur when the margin in the trading account falls below the required level to maintain open positions.