In the previous lesson, three terms related to margin was discussed. There is another term called used margin, which comes under the same roof of the margin requirement and required margin. And in the lesson, this term shall be discussed in detail. Apart from that, this lesson shall touch base on the concept of Equity in margin trading.
Before diving directly into the topic, let’s first brush up the previously discussed terms as they form the base for this lesson. To Start off with the Required Margin, it is basically the units of currency that is needed to open a position. Note that this is not the actual amount of the position size but the amount after applying the Margin Requirement to the required margin.
The Used margin is the term that is very similar to the required margin. In fact, the used margin is the required margin. However, there is a thin line difference between the two.
The Used margin is the amount that is blocked by the broker when positions are open on a trader’s account. This definition might seem the same as that of the required margin. The difference is that the required margin talks about one single trade, while the used margin considers the sum of the required margin of all the trades. This is the amount that is ‘used’ by the broker when the trade is open and cannot be utilized for taking new positions. However, once the positions are closed, this used margin is unblocked and returned to the account balance.
Let’s say a trader has $1,000 in his account and wishes to open trades on EUR/USD and USD/CHF.
Let’s assume he is willing to go short 10,000 units on USD/CHF and long 1,000 units on EUR/USD. Let’s keep the margin requirement for USD/CHF and EUR/USD to 2%, respectively. Before going into the calculation of the used margin, the required margin is calculated as follows:
Required margin = Notional Value x Margin Requirement = $10,000 x 0.02 = $200
Required margin = Notional Value x Margin requirement = $1,000 x 0.02 = $20
Therefore, when positions on both trades are opened, the used margin turns out to be $220*.
*Used margin = $200 + $20 = $220
Equity is a variable term that represents the current value of the account balance. Equity constantly changes when traders have their positions running. This proves to be an important term because it determines how many more positions can be taken on this account.
Calculation of Equity
The calculation of Equity is simple. It is the algebraic sum of the account balance and the unrealized P/L. When there are no positions open, the Equity will be the same as the account balance as the unrealized P/L is 0. And when there are any running positions, the Equity will be determined by both account balance and unrealized P/L.
Equity = Account Balance + Floating P/L
From this, it can be inferred that, when trades are running in the positive, the Equity rises, and when they’re in the negative, the Equity drops.
Thus, this completes the lesson on Used Margin and Equity. In the next lesson, some advanced term on margin shall be introduced. Don’t forget to take the below quiz before you move on.