Forex trading is a highly dynamic and complex market, and it requires traders to have a thorough understanding of various concepts and calculations. One of the most important concepts that traders need to master is free margin, which is a key factor in determining the amount of available funds that they can use for trading. In this article, we will explain how to calculate free margin in forex.
What is Free Margin?
Before we dive into the calculations, let’s first define what free margin is. Free margin is the amount of trading capital that a trader has available after they have opened a position in the forex market. In other words, it is the difference between the trader’s equity and their used margin. Equity is the total value of a trader’s account, including profits and losses, while used margin is the amount of money that has been set aside to keep a position open.
Calculating Free Margin
Calculating free margin is a fairly simple process, and it requires the trader to know their equity, used margin, and account currency. Here is the formula for calculating free margin:
Free Margin = Equity – Used Margin
Let’s break down this formula and understand the different components.
Equity
As mentioned earlier, equity is the total value of a trader’s account, including profits and losses. It is calculated by adding the trader’s account balance and their unrealized profits or losses.
Equity = Account Balance + Unrealized Profit/Loss
For example, if a trader has an account balance of $10,000 and an unrealized profit of $500, their equity would be $10,500.
Used Margin
Used margin is the amount of money that has been set aside to keep a position open. It is calculated by multiplying the position size by the margin requirement.
Used Margin = Position Size x Margin Requirement
For example, if a trader wants to open a position of 1 lot in the EUR/USD currency pair, and the margin requirement is 2%, the used margin would be calculated as follows:
Used Margin = 1 x 100,000 x 0.02 = $2,000
Account Currency
The account currency is the currency in which the trader’s account is denominated. This is important because it determines the exchange rate that is used to convert the currency pair being traded into the trader’s account currency.
For example, if a trader’s account is denominated in US dollars and they are trading the EUR/USD currency pair, the exchange rate used to calculate the profits and losses would be the EUR/USD exchange rate.
Once the trader has calculated their equity and used margin, they can use the formula mentioned above to calculate their free margin. Let’s take an example to understand this better.
Example
Suppose a trader has an account balance of $10,000, and they want to open a position of 1 lot in the EUR/USD currency pair. The margin requirement for this currency pair is 2%. The exchange rate for the EUR/USD currency pair is currently 1.2000. Here’s how to calculate the free margin:
1. Calculate the used margin:
Used Margin = 1 x 100,000 x 0.02 = $2,000
2. Calculate the equity:
Equity = Account Balance + Unrealized Profit/Loss
= $10,000 + $500 (unrealized profit)
= $10,500
3. Calculate the free margin:
Free Margin = Equity – Used Margin
= $10,500 – $2,000
= $8,500
Conclusion
Free margin is an important concept that traders need to understand when trading forex. It is the amount of trading capital that a trader has available after they have opened a position, and it is calculated by subtracting the used margin from the equity. By understanding how to calculate free margin, traders can make informed decisions about their trading strategies and manage their risk effectively.
