What is a used margin?
To further understand free margin, let us first define used margin. When opening a trade, your forex broker will set aside a portion of your position’s total size to cover the potential losses you may encounter and call this required margin. It is also possible to open more than one position simultaneously, and they would individually have their required margins. If we add all of these, we call the sum ‘used margin.’ Used margins are all locked up unless the trader closes the position. Required and used margins are needed to keep a position open and active.
The second type of margin
Aside from the used margin, we also have the free margin. It is the difference that we can get between equity and used margin. In short, free margin is a trader’s account equity not involved with margin and current open positions. Unlike used margins, they are not locked up. You can still use these amounts to open new positions. We can also think of free margin as the amount that open positions can move opposite to your desired direction before receiving a margin call or stop out. If you encounter terms like usable margin, usable maintenance margin, available margin, or “available to trade,” know that these are all synonymous with free margin.
How does one calculate free margin
Free margin= equity – used margin
This is the formula that we can follow when we calculate the free margin. If you currently have profitable open positions, your equity increases. An increase in equity also means free margin. It also means that with an open position, you have unrealized profit and loss. If your unrealized P/L is on the unrealized profit side, you will have higher equity and free margin. Contrary to that, if your unrealized P/L is on the losing side, that means lesser equity, and lesser equity means more inferior free margin.
Let us cite an example where there is no open position
You do not have any open positions, but you have deposited $2,000 in your trading account.
First step: Calculate your equity.
Equity = account balance + unrealized profit or loss
$2,000= $2,000 +$0
Your equity is also $2,000. It is the same as your account balance because you do not have any active trades at the moment, so you do not have any unrealized profit or loss to put in the equation.
Second step: Calculating your free margin
Free margin = equity – used margin
$2,000= $2,000 – $0
Your free margin is also equal to your equity because you do not have any required or used margin as you do not have any open positions. In this case, your free margin, balance, and equity are all the same.
Let us cite an example when you have an open position
You want to open a position, and you deposited $1,000 in your account. Below is the process of how to end up with the free margin.
First step: Calculate your required margin
Let us say that you want to go long and open a EUR/ USD mini lot with 10,000 units and the margin requirement is 3%. Now, how much is your required margin to open this position and keep it open?
Required margin = notional value * margin requirement
$300= $10,000 * 0.03
Let us enumerate facts on how we ended up having a $300 required margin.
- The trading account’s currency is also the same as the base currency, which is EUR.
- The notional value is a mini lot, so we ended up having a $10,000 notional value.
Second step: Calculating your used margin
As we have mentioned, the used margin is equal to all the open position’s required margins added. Since you only have one open position, your used margin is also the same as your required margin.
Third step: Calculating your equity
Assuming that the price went in your desired direction, you now see that you have $150 gains.
Equity= account balance + unrealized P/L
$2,150= $2,000 + $150
Your account equity is $2150.
Final step: calculating your free margin
Free margin = equity – used margin
$1850= $2150 – $300
Your free margin is $1850.