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Free Margin
Definition
Margin can be classified as either “used” or “free”. Free Margin is the difference between Equity and Used Margin.
Calculation
- Equity: This is the total value of the trader’s account, including the initial deposit and any unrealized profits or losses from their open positions.
- Used Margin: This is the total margin requirement for all the trader’s open positions. It’s the amount of capital that is “tied up” to maintain those positions.
- Free Margin = Equity – Used Margin
Interpretation
Free Margin can be thought of in two ways:
Available to open new positions
The Free Margin represents the amount of capital the trader can use to open new trades. This is important because brokers require a certain amount of margin to be deposited before opening a new position.
Buffer against losses
The Free Margin acts as a cushion against potential losses on the trader’s existing positions. As long as the account balance (Equity) remains above the Used Margin, the trader will not receive a margin call or experience a stop-out (forced position closure).
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Calculating Free Margin
Equity and Used Margin
Equity
Equity represents the total value of the trader’s account, including the initial deposit and any unrealized profits or losses from their open positions.
Used Margin
Used Margin is the total margin requirement for all the trader’s open positions. It’s the amount of capital that is “tied up” to maintain those positions.
Formula for Free Margin
The formula for calculating Free Margin is:
Free Margin = Equity – Used Margin
Example: No Open Positions
Let’s start with a simple example where the trader has no open positions.
- Deposit: The trader deposits $1,000 into their trading account.
- Equity: Since the trader has no open positions, the Equity is equal to the account balance, which is $1,000.
- Used Margin: With no open positions, the Used Margin is $0.
- Free Margin: Plugging the values into the formula:
- Free Margin = Equity – Used Margin
- Free Margin = $1,000 – $0 = $1,000
In this scenario, the trader’s Free Margin is equal to their account balance of $1,000, as they have no open positions and no margin being used.
Example: With Open Positions
Now, let’s consider a scenario where the trader has open positions.
- Deposit: The trader deposits $1,000 into their trading account.
- Open Positions: The trader opens positions that require $600 in Used Margin.
- Equity: Assuming the trader’s open positions have not generated any unrealized profits or losses, the Equity is still $1,000.
- Used Margin: The Used Margin is $600, as this is the total margin requirement for the trader’s open positions.
- Free Margin: Plugging the values into the formula:
- Free Margin = Equity – Used Margin
- Free Margin = $1,000 – $600 = $400
In this scenario, the trader’s Free Margin is $400, as they have $400 in excess equity that is not being used as margin for their open positions.
Example: Open a Long USD/JPY Position
Step 1: Calculate Required Margin
Let’s say you have an account balance of $1,000 and you want to go long USD/JPY, opening a 1 mini lot (10,000 units) position. The Margin Requirement is 4%.
To calculate the Required Margin, we use the formula:
Required Margin = Notional Value x Margin Requirement
The Notional Value of the 1 mini lot position is $10,000 (10,000 units of USD). Plugging in the values:
Required Margin = $10,000 x 0.04 = $400
So, the Required Margin to open this position is $400.
Step 2: Calculate Used Margin
Since we only have this one position open, the Used Margin is equal to the Required Margin, which is $400.
Step 3: Calculate Equity
Let’s assume the price has moved slightly in your favor, and your position is now trading at breakeven, with a Floating P/L of $0.
Equity = Account Balance + Floating Profits (or Losses)
Equity = $1,000 + $0 = $1,000
Step 4: Calculate Free Margin
Now, we can calculate the Free Margin using the formula:
Free Margin = Equity – Used Margin
Free Margin = $1,000 – $400 = $600
The Free Margin is $600, which means you have $600 available that is not being used as margin for the open position.
Roundup
Free Margin
– Free Margin is the money that is NOT “locked up” due to an open position and can be used to open new positions.
– When Free Margin is at zero or less, additional positions cannot be opened.
Previous Lessons Recap
In previous lessons, we covered the following concepts:
Margin Trading
– Learned why it’s important to understand how your margin account works.
Balance
– Your account balance is the cash you have available in your trading account.
Unrealized and Realized P/L
– Learned how profit or losses affect your account balance.
Margin
– Required Margin is the amount of money that is set aside and “locked up” when you open a position.
Used Margin
– Used Margin is the total amount of margin that’s currently “locked up” to maintain all open positions.
Equity
– Equity is your Balance plus the floating profit (or loss) of all your open positions.
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