3 Types of Forex Market Analysis

There are three types of market analysis:

 

  1. Technical Analysis
  2. Fundamental Analysis
  3. Sentiment Analysis

There has always been a constant debate as to which analysis is better, but to tell you the truth, you need to know all three.

Three types of forex market analysis

It’s kind of like standing on a three-legged stool.

If one of the legs is weak, the stool will break under your weight and you’ll fall flat on your face.

The same holds true in trading.

Oh, wait. Since the stool is supposed to represent how a trader goes about thinking and analyzing the market, it’s missing a brain.

But wait! The stool needs more brains!

There technically should be three brains….to represent the three different types of thought process…

Three Typess to Analyze Markets

Ahhh. There we go.

You need to have three “brains” when thinking about the market.

If your analysis on any of the three types of analysis is weak and you ignore it, there’s a good chance that it will cause you to lose out on your trade!

What is a Spread in Forex Trading?

The difference between these two prices is known as the spread.

Also known as the “bid/ask spread“.

The spread is how “no commission” brokers make their money.

Instead of charging a separate fee for making a trade, the cost is built into the buy and sell price of the currency pair you want to trade.

From a business standpoint, this makes sense. The broker provides a service and has to make money somehow.

  • They make money by selling the currency to you for more than they paid to buy it.
  • And they also make money by buying the currency from you for less than they will receive when they sell it.
  • This difference is called the spread.

It’s just like if you were trying to sell your old iPhone to a store that buys used iPhones. (A smartphone with only two rear cameras? Yuck!)

Price Spread

In order to make a profit, it will need to buy your iPhone at a price lower than the price it’ll sell it for.

If it can sell the iPhone for $500, then if it wants to make any money, the most it can buy from you is $499.

That difference of $1 is the spread.

So when a broker claims “zero commissions” or “no commission”, it’s misleading because while there is no separate commission fee, you still pay a commission.

It’s just built into the bid/ask spread!

How is the Spread in Forex Trading Measured?

The spread is usually measured in pips, which is the smallest unit of the price movement of a currency pair.

For most currency pairs, one pip is equal to 0.0001.

An example of a 2 pip spread for EUR/USD would be 1.1051/1.1053.

Bid, Ask and Spread Example

Currency pairs involving the Japanese yen are quoted to only 2 decimal places (unless there are fractional pips, then it’s 3 decimals).

For example, USD/JPY would be 110.00/110.04. This quote indicates a spread of 4 pips.

What Types of Spreads are in Forex?

The type of spreads that you’ll see on a trading platform depends on the forex broker and how they make money.

There are two types of spreads:

  1. Fixed
  2. Variable (also known as “floating”)

Fixed vs. Variable Spreads

Fixed spreads are usually offered by brokers that operate as a market maker or “dealing desk” model while variable spreads are offered by brokers operating a “non-dealing desk” model.

What are Fixed Spreads in Forex?

Fixed spreads stay the same regardless of what market conditions are at any given time. In other words, whether the market is volatile like Kanye’s moods or quiet as a mouse,  the spread is not affected. It stays the same.

 

Fixed spreads are offered by brokers that operate as a market maker or “dealing desk” model.

 

Using a dealing desk, the broker buys large positions from their liquidity provider(s) and offers these positions in smaller sizes to traders.

This means that the broker acts as the counterparty to their clients’ trades.

By having a dealing desk, this allows the forex broker to offer fixed spreads because they are able to control the prices they display to their clients.

What are the Advantages of Trading With Fixed Spreads?

Fixed spreads have smaller capital requirements, so trading with fixed spreads offer a cheaper alternative for traders who don’t have a lot of money to start trading with.

Trading with fixed spreads also makes calculating transaction costs more predictable. Since spreads never change, you’re always sure of what you can expect to pay when you open a trade.

What are the Disadvantages of Trading With Fixed Spreads?

Requotes can occur frequently when trading with fixed spreads since pricing is coming from just one source (your broker).

And by frequently, we mean almost as frequently as Instagram posts from Kardashian sisters!

 

There will be times when the forex market is volatile and prices are rapidly changing. Since spreads are fixed, the broker won’t be able to widen the spread to adjust for current market conditions.

 

So if you try to enter a trade at a specific price, the broker will “block” the trade and ask you to accept a new price. You will be “re-quoted” with a new price.

The requote message will appear on your trading platform letting you know that price has moved and asks you whether or not you are willing to accept that price. It’s almost always a price that is worse than the one you ordered.

Slippage is another problem. When prices are moving fast, the broker is unable to consistently maintain a fixed spread and the price that you finally end up after entering a trade will be totally different than the intended entry price.

Slippage is similar to when you swipe right on Tinder and agree to meet up with that hot gal or guy for coffee and realize the actual person in front of you looks nothing like the photo.

What are Variable Spreads in Forex?

As the name suggests, variable spreads are always changing. With variable spreads, the difference between the bid and ask prices of currency pairs are constantly changing.

 

Variable spreads are offered by non-dealing desk brokers. Non-dealing desk brokers get their pricing of currency pairs from multiple liquidity providers and pass on these prices to the trader without the intervention of a dealing desk.

 

This means they have no control over the spreads. And spreads will widen or tighten based on the supply and demand of currencies and the overall market volatility.

Typically, spreads widen during economic data releases as well as other periods when the liquidity in the market decreases (like during holidays and when the zombie apocalypse begins).

Wide Forex Broker Spread

For example, you may want to buy EURUSD with a spread of 2 pips, but just when you’re about to click buy, the U.S. unemployment report is released and the spread rapidly widens to 20 pips!

Oh, and spreads may also widen when Trump randomly tweets about the U.S. dollar when he was still the President.

What are the Advantages of Trading With Variable Spreads?

Variable spreads eliminate experiencing requotes. This is because the variation in the spread factors in changes in price due to market conditions.

(But just because you won’t get requoted doesn’t mean you won’t experience slippage.)

Trading forex with variable spreads also provides more transparent pricing, especially when you consider that having access to prices from multiple liquidity providers usually means better pricing due to competition.

What are the Disadvantages of Trading With Variable Spreads?

Variable spreads aren’t ideal for scalpers. The widened spreads can quickly eat into any profits that the scalper makes.

Variable spreads are just as bad for news traders. Spread may widen so much that what looks like a profitable can turn into an unprofitable within a blink of an eye.

Fixed vs Variable Spreads: Which is Better?

The question of which is a better option between fixed and variable spreads depends on the need of the trader.

There are traders who may find fixed spreads better than using variable spread brokers. The reverse may also be true for other traders.

Generally speaking, traders with smaller accounts and who trade less frequently will benefit from fixed spread pricing.

And traders with larger accounts who trade frequently during peak market hours (when spreads are the tightest) will benefit from variable spreads.

Traders who want fast trade execution and need to avoid requotes will want to trade with variable spreads.

How to Avoid a Margin Call

If you fail to understand the concept of margin or not knowing what to do when faced with a margin call from your broker, you will definitely experience the shock of your trading account blow up.

Here are five ways to avoid a margin call.

1. Know WTF a margin call is.

Understanding what margin call is and how it works is the first step in knowing how to avoid one.

 

Most new traders want to focus on other details of trading such as technical indicators or chart patterns, but little thought is given to the other important elements such as margin requirements, equity, used margin, free margin, and margin levels.

 

If you’re hit with a margin call out of the blue, this usually means you have no clue what causes a margin call and are opening trades without considering margin requirements.

If this is you, you are doomed to fail as a trader. Guaranteed.

A margin call occurs when your account’s Margin Level has fallen below the required minimum level. At this point, your broker will notify you and demand that you deposit more money in your account to meet the minimum margin requirements.

Nowadays, this process is automated so your broker will probably notify you by email or text rather than receiving an actual phone call.

2. Know what the margin requirements are even before you place ANY order.

Knowing the margin requirements BEFORE you open a trade is crucial.

 

The concept of margin call isn’t thought about much by most traders, especially when they are placing pending orders with their broker.

 

Typically, traders tend to place an order with their broker and it remains open until the limit price is reached or until the pending order expires.

When you place a pending order, your trading account is not affected because margin is not applied to pending orders.

However, this exposes you to the risk of the pending order being automatically filled.

 

If you’re not properly monitoring your margin level, when this order gets filled, it could result in a margin call.

 

In order to avoid such a situation, you need to consider margin requirements before placing an order.

You have to account for the margin amount that will be deducted from your free margin, as well as having some additional margin so your trade will have some breathing room.

When you have multiple pending orders open, it can get quite confusing and if you’re not careful, these orders could result in a margin call.

To avoid such a tragedy, it’s crucial that you understand the margin requirements for each position you plan to enter.

3. Use stop loss orders or trailing stops to avoid margin calls.

If you don’t know what a stop loss order is, you’re on your way to losing a lot of money.

As a refresher though, a stop loss order is basically a stop order sent to the broker as a pending order. This order is triggered when the price moves against your trade.

 

For example, if you were long 1 mini lot on USD/JPY at 110.50, and you set your stop loss at 109.50.

 

This means that when USD/JPY falls to 109.50, your stop order is triggered and your long position is closed for a loss of 100 pips or $100.

If you traded WITHOUT a stop loss order and USDJPY continued to fall, at some point, depending on how much money you have in your account, you would trigger a margin call.

A stop loss order or a trailing stop order prevents you from taking on further losses, which helps prevent getting a margin call.

4. Scale in positions rather than entering all at once.

Another reason why some traders end up with a margin call is that they misjudge price movement.

For example, you think GBP/USD has gone up way too high and too fast and you believe that there is no way price can go higher, so you open a HUGE short position.

This type of overconfident trading increases the probability of triggering a margin call.

To avoid this, one approach is to build a trade position, also known as “scaling in”.

Instead of trading with 4 mini lots right off the bat, start off with 1 mini lot. Then add or “scale in” to the position as the price moves in your favor.

 

While you continue adding new positions, you can also start moving the stop losses on the previous positions to reduce potential losses or even lock in profits.

Position scaling can help you magnify your profits while trading risk-free when you combine all the positions.

While this usually means that you’ll have to allocate more capital towards the larger margin requirement, scaling in positions at different price levels and using different stop loss levels means that your risk of losses on the trade is spread out which lowers the probability of a margin call (when compared to opening one big position size all at once).

5. Know WTH you are doing as a trader.

It’s not uncommon to hear about noob traders who are hit with a margin call and don’t know what the hell happened.

These traders are the types of traders who are just focused on how much money they can make and don’t know what the hell they are doing and don’t fully understand the risks of trading.

Don’t be that trader.

The Relationship Between Margin and Leverage

What is the relationship between Margin and Leverage?

You use margin to create leverage.

Leverage is the increased “trading power” that is available when using a margin account.

Leverage allows you to trade positions LARGER than the amount of money in your trading account.

Leverage is expressed as a ratio.

Leverage is the ratio between the amount of money you really have and the amount of money you can trade.

It is usually expressed with an “X:1” format.

For example, if you wanted to trade 1 standard lot of USD/JPY without margin, you would need $100,000 in your account.

But with a Margin Requirement of just 1%, you would only have to deposit $1,000 in your account.

The leverage provided for this trade would be 100:1.

Here are examples of Leverage Ratios depending on the Margin Requirement:

Currency Pair Margin Requirement Leverage Ratio
EUR/USD 2% 50:1
GBP/USD 5% 20:1
USD/JPY 4% 25:1
EUR/AUD 3% 33:1

Here’s how to calculate Leverage:

Leverage = 1 / Margin Requirement

For example, if the Margin Requirement is 2%, here’s how to calculate leverage:

50 = 1 / .02

The leverage is 50, which is expressed as a ratio, 50:1

Here’s how to calculate the Margin Requirement based on the Leverage Ratio:

Margin Requirement = 1 / Leverage Ratio

For example, if the Leverage Ratio is 100:1, here’s how to calculate the Margin Requirement.

0.01 = 1 / 100

The Margin Requirement is 0.01 or 1%.

As you can see, leverage has an inverse relationship to margin.

“Leverage” and “margin” refer to the same concept, just from a slightly different angle.

 

When a trader opens a position, they are required to put up a fraction of that position’s value “in good faith”. In this case, the trader is said to be “leveraged”.

 

The “fraction” part which is expressed in percentage terms is known as the “Margin Requirement”. For example, 2%.

The actual amount that is required to be put up is known as the “Required Margin”.

For example, 2% of a $100,000 position size would be $2,000.

The $2,000 is the Required Margin to open this specific position.

Since you are able to trade a $100,000 position size with just $2,000, your leverage ratio is 50:1.

Leverage = 1 /Margin Requirement

50 = 1 / 0.02

Margin vs. Leverage

Forex Margin vs. Securities Margin

Forex margin and securities margin are two very different things. Understanding the difference is important.

In the securities world, margin is the money you borrow as a partial down payment, usually up to 50% of the purchase price, to buy and own a stock, bond, or ETF.

This practice is often referred to as “buying on margin”.

So if you’re trading stocks on margin, you’re borrowing money from your stock broker to purchase stock. Basically, a loan from the brokerage firm.

In the forex market, margin is the amount of money that you must deposit and keep on hand with your trading platform when you open a position.

It is NOT a down payment and you do NOT own the underlying currency pair.

Margin can be looked at as a good faith deposit or collateral that’s used to ensure each party (buyer and seller) can meet their obligations of the agreement.

Unlike margin in stock trading, margin in forex trading is not borrowed money.

When trading forex, nothing is actually being bought or sold, only the agreement (or contract) to buy or sell are exchanged, so borrowing is not needed.

The term “margin” is used across multiple financial markets. However, there is a difference between how margin is used when trading securities versus when trading forex. Understanding this difference is essential prior to trading forex.

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What is a Stop Out Level?

In forex trading, a Stop Out Level is when your Margin Level falls to a specific percentage (%) level in which one or all of your open positions are closed automatically (“liquidated”) by your broker.

This liquidation happens because the trading account can no longer support the open positions due to a lack of margin.

More specifically, the Stop Out Level is when the Equity is lower than a specific percentage of your Used Margin.

If this level is reached, your broker will automatically start closing out your trades starting with the most unprofitable one until your Margin Level is back above the Stop Out Level. Stop Out Level Diagram

If your Margin Level is at or below the Stop Out Level, the broker will close any or all of your open positions as quickly as possible in order to protect you from possibly incurring further losses.

This act of closing your positions is called a Stop Out.

Keep in mind that a Stop Out is not discretionary. Once the liquidation process has started, it is usually not possible to stop it since the process is automated.

 

Your broker’s customer support team will probably NOT be able to help you aside from lending an ear while you weep loudly over the phone.

The Stop Out Level is also known as the Margin Closeout Value, Liquidation Margin, or Minimum Required Margin.

Example: Stop Out Level at 20%

Let’s say your forex broker has a Stop Out Level at 20%.

This means that your trading platform will automatically close your position if your Margin Level reaches 20%.

Stop Out Level = Margin Level @ 20%

Let’s continue with the example from the previous lesson, What is a Margin Call Level?

You’ve already received a Margin Call when the Margin Level had reached 100% but still decide not to deposit more funds because you think the market will turn.

Not only are you a sucky trader, but you’re a crazy trader also. A sucky crazy trader.

 

Anyways, your sucky crazy self ends up…absolutely WRONG.

The market continues to fall.

You’re now down 960 pips.

At $1/pip, you now have a floating loss of $960!

This means your Equity is now $40.

Equity = Balance + Floating P/L

$40 = $1000 - $960

Your Margin Level is now 20%.

Margin Level = (Equity / Used Margin) x 100%

20% = ($40 / $200) x 100%

*Used Margin can’t go below $200 because that’s the Required Margin that was needed to open the position in the first place.

At this point, your position will be automatically closed (“liquidated”).

When your position is closed, the Used Margin that was “locked up” will be released.

It will become Free Margin.

The end result for you will be depressing though.

Your floating loss of $960 will be “realized”, and your new Balance will be $40!

Since you don’t have any open trades, your Equity and Free Margin will also be $40.

Here’s how your account metrics would look like in your trading platform at each Margin Level threshold:

Margin Level Equity Used Margin Free Margin Balance Floating P/L
Margin Call Level 100% $200 $200 $0 $1,000 -$800
Stop Out Level 20% $40 $200 $0 $1,000 -$960
Stop Out (Liquidation) $40 $40 $40

If you experience a Stop Out and see the aftermath in your account, this is how your eyes feel…

If you had multiple positions open, the broker usually closes the least profitable position first.

Each position that is closed “releases” Used Margin, which increases your Margin Level.

But if closing this position is still not enough to get back the Margin Level above 20%, your broker will continue to close positions until it does.

The Stop Out Level is meant to prevent you from losing more money than you have deposited.

If your trade continued to keep losing, eventually, you’d have no more money in your account and you’d end up with a negative account balance!

Brokers would prefer not to have to come knocking on your door with a baseball bat to collect the unpaid balance, so a Stop Out is meant to try and… STOP… your Balance from going negative.

What if I have multiple positions open?

The example above covered the scenario with you trading a single position. But what if you had MULTIPLE positions open?

Hmmm.

Sounds like you love gambling so here’s an example of how the liquidation process would work if you had two or more positions open.

Each broker has its own specific liquidation process so be sure to check with yours. BUT this is a popular approach and will at least give you a good idea of what kind of horror you might experience if you’re trading too BIG.

Let’s pretend the Stop Out level is at 100%.

If at any point, the Margin Level drops below 100% of the margin required.. you will experience an AUTO LIQUIDATION of the position that has the largest unrealized loss! 

So if you have multiple positions, the open position with the greatest unrealized loss is closed first, followed by the next largest losing position, followed by the next largest losing position, and so on, UNTIL the Margin Level (maintenance margin) is back to 100% or higher.

Depending on the size and unrealized P&L of the open positions, all your open positions could be liquidated in order to meet the margin requirement!

Remember, YOU, and YOU alone, are responsible for monitoring your account and making sure you are maintaining the required margin at all times to support your open positions.

You’ve been warned. Don’t be crying to your broker when your position gets auto-liquated.

You can still cry of course. But only in front of a mirror.

Now that we’ve covered all the important metrics that you need to know in your trading platform, let’s take everything you’ve learned so far about margin trading and put it all together using different trading scenarios.

What is a Margin Call Level?

When this threshold is reached, you are in danger of the POSSIBILITY of having some or all of your positions forcibly closed (or “liquidated“).

The Margin Level is the “metric” and the “Margin Call Level” is a specific “value” of the metric (which is the Margin Level).

Yeah, it’s awkward. But don’t blame us, we’re not the ones who name these things.

For example, some forex brokers have a Margin Call Level of 100%.

Margin Call Level Diagram

In the specific example above,  if the Margin Level in your account falls to 100% or lower, a “Margin Call” will occur.

Not familiar with the concept of Margin Level? Read our lesson, What is Margin Level?

What is a Margin Call?

Margin Call is when your broker notifies you that your Margin Level has fallen below the required minimum level (the “Margin Call Level”).

This notification used to be an actual phone call, but nowadays, it’s usually an email or text message.

Regardless of how you’re actually notified, the feeling isn’t great.

Receive a Margin Call

A Margin Call occurs when your floating losses are greater than your Used Margin.

This means that your Equity is less than your Used Margin (since floating losses reduce your Equity).

“Margin Call Level” vs. “Margin Call”

Traders tend to get confused between a Margin Call Level and Margin Call.

  • A “Margin Call Level” is a threshold set by your broker that will trigger a “Margin Call”. It is a specific percentage (%) value of the Margin Level. For example, when the Margin Level is 100%.
  • A “Margin Call” is an event. When a Margin Call occurs, your broker takes some sort of action. Usually, the action is “to send a notification”. This event only occurs when the Margin Level falls below a certain value. This value is the “Margin Call Level”.

Think about boiling water.

Boiling Water

For water to normally boil, the temperature must reach 100° C.

  • The Margin Level is equivalent to temperature. Temperature can vary and can be any number like 0° C, 47° C, 89° C, etc.
  • The Margin Call Level is equivalent to 100° C, which is a specific temperature.
  • Margin Call is equivalent to water boiling, the event when the liquid changes into a vapor.

Example: Margin Call Level at 100%

Let’s say your forex broker has a Margin Call Level at 100%. This means that your trading platform will send you a warning notification if your Margin Level reaches 100%.

Margin Call Level = Margin Level @ 100%

Aside from receiving a notification, your trading will also be affected.

If your account’s Margin Level reaches 100%, you will NOT  be able to open any new positions, you can only close existing positions.

A Margin Call Level at 100% means that your Equity is equal to or lower than your Used Margin.

This occurs because you have open positions whose floating losses continue to INCREASE.

Let’s say you have a $1,000 account and you open a USD/CHF position with 1 mini lot (10,000 units) that has a $200 Required Margin.

Since you only have one position open, Used Margin will also be $200 (same as Required Margin).
Margin Call Level Example with USDCHF

At this point, you still suck at trading so right away, your trade quickly starts losing.

It’s losing big time. (You really suck at trading.)

You’re now down 800 pips. 

At $1/pip, this means you have a floating loss of $800!

This means your Equity is now $200.

Equity = Balance + Floating P/L

$200 = $1000 - $800

Your Margin Level is now 100%.

What is Margin Level?

Margin Level allows you to know how much of your funds are available for new trades.

The higher the Margin Level, the more Free Margin you have available to trade.

The lower the Margin Level, the less Free Margin available to trade, which could result in something very bad…like a Margin Call or a Stop Out (which will be discussed later).

How to Calculate Margin Level

Here’s how to calculate Margin Level::

Margin Level = (Equity / Used Margin) x 100%

Your trading platform will automatically calculate and display your Margin Level.

If you don’t have any trades open, your Margin Level will be ZERO.

Margin Level is very important. Forex brokers use margin levels to determine whether you can open additional positions.

 

Different brokers set different Margin Level limits, but most brokers set this limit at 100%.

This means that when your Equity is equal to or less than your Used Margin, you will NOT be able to open any new positions.

If you want to open new positions, you will have to close existing positions first.

Example #1: Open a long USD/JPY position with 1 mini lot

Let’s say you have an account balance of $1,000.

Account Balance

Step 1: Calculate Required Margin

You want to go long USD/JPY and want to open 1 mini lot (10,000 units) position. The Margin Requirement is 4%.

How much margin (Required Margin) will you need to open the position?

Since USD is the base currency. this mini lot is 10,000 dollars, which means the position’s Notional Value is $10,000.

Required Margin = Notional Value x Margin Requirement

$400 = $10,000 x .04

Assuming your trading account is denominated in USD since the Margin Requirement is 4%, the Required Margin will be $400.

Required Margin Example

Step 2: Calculate Used Margin

Aside from the trade we just entered, there aren’t any other trades open.

Since we just have a single position open, the Used Margin will be the same as Required Margin.

Used Margin Example

Step 3: Calculate Equity

Let’s assume that the price has moved slightly in your favor and your position is now trading at breakeven.

This means that your Floating P/L is $0.

Let’s calculate the Equity:

Equity = Account Balance + Floating Profits (or Losses)

$1,000 = $1,000 + $0

The Equity in your account is now $1,000.

Equity with Breakeven Floating P/L

Step 4: Calculate Margin Level

Now that we know the Equity, we can now calculate the Margin Level:

Margin Level = (Equity / Used Margin) x 100%

250% = ($1,000 / $400) x 100%

The Margin Level is 250%.Margin Level

If the Margin Level is 100% or less, most trading platforms will not allow you to open new trades.

In the example, since your current Margin Level is 250%, which is way above 100%, you’ll still be able to open new trades.

 

What is Free Margin?

Used Margin, which is just the aggregate of all the Required Margin from all open positions, was discussed in a previous lesson.

Free Margin is the difference between Equity and Used Margin.

Free Margin refers to the Equity in a trader’s account that is NOT tied up in margin for current open positions.

Free Margin is also known as “Usable Margin” because it’s margin that you can “use”….it’s “usable”.

Free Margin can be thought of as two things:

  1. The amount available to open NEW positions.
  2. The amount that EXISTING positions can move against you before you receive a Margin Call or Stop Out.

 

Don’t worry about what a Margin Call and Stop Out are. They will be discussed later.

 

For now, just know they’re bad things. Like acne breakouts, you don’t want to experience them.

Free Margin is also known as Usable MarginUsable Maintenance MarginAvailable Margin, and “Available to Trade“.

How to Calculate Free Margin

Here’s how to calculate Free Margin:

Free Margin = Equity - Used Margin

If you have open positions, and they are currently profitable, your Equity will increase, which means that you will have more Free Margin as well.

Floating profits increase Equity, which increases Free Margin. 

If your open positions are losing money, your Equity will decrease, which means that you will also have less Free Margin as well.

Floating losses decrease Equity, which decreases Free Margin. 

Example: No Open Positions

Let’s start with an easy example.

You deposit $1,000 in your trading account.

You don’t have any open positions, what is your Free Margin?

Step 1: Calculate Equity

If you don’t have any open position, calculating the Equity is easy.

Equity = Account Balance + Floating Profits (or Losses)

$1,000 = $1,000 + $0

The Equity would be the SAME as your Balance.

Since you don’t have any open positions, you don’t have any floating profits or losses.Account Equity

Step 2: Calculate Free Margin

If you don’t have any open positions, then the Free Margin is the SAME as the Equity.

Free Margin = Equity - Used Margin

$1,000 = $1,000 - $0

Since you don’t have any open positions, there is no margin being “used”.

This means that your Free Margin will be the same as your Balance and Equity.Free Margin

Example: Open a Long USD/JPY Position

Now let’s make it a bit more complicated by entering a trade!

Let’s say you have an account balance of $1,000.Account Balance

Step 1: Calculate Required Margin

You want to go long USD/JPY and want to open 1 mini lot (10,000 units) position. The Margin Requirement is 4%.

How much margin (Required Margin) will you need to open the position?

Since USD is the base currency. this mini lot is 10,000 dollars, which means the position’s Notional Value is $10,000.

Required Margin = Notional Value x Margin Requirement

$400 = $10,000 x .04

Assuming your trading account is denominated in USD, since the Margin Requirement is 4%, the Required Margin will be $400.Required Margin Example

Step 2: Calculate Used Margin

Aside from the trade we just entered, there aren’t any other trades open.

Since we just have a SINGLE position open, the Used Margin will be the same as Required Margin.Used Margin Example

Step 3: Calculate Equity

Let’s assume that the price has moved slightly in your favor and your position is now trading at breakeven.

This means that your floating P/L is $0.

Let’s calculate your Equity:

Equity = Account Balance + Floating Profits (or Losses)

$1,000 = $1,000 + $0

The Equity in your account is now $1,000.Equity with Breakeven Floating P/L

Step 4: Calculate Free Margin

Now that we know the Equity, we can now calculate the Free Margin:

Free Margin = Equity - Used Margin

$600 = $1,000 - $400

The Free Margin is $600.Free Margin Example

As you can see, another way to look at Equity is the sum of your Used and Free margin.

Equity = Used Margin + Free Margin
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What is Equity?

Equity is the current value of the account and fluctuates with every tick when looking at your trading platform on your screen.

It is the sum of your account balance and all floating (unrealized) profits or losses associated with your open positions.

As your current trades rise or fall in value, so does your Equity.

How to Calculate Equity If You Have No Trades Open

If you do NOT have any open positions, then your Equity is the same as your Balance.

Equity = Account Balance

Example: Account Equity When You Have No Open Trades

You deposit $1,000 in your trading account.

Since you haven’t opened any trades yet, your Balance and Equity is the same.Account Equity

How to Calculate Equity If You Have Trades Open

If you have open positions, your Equity is the sum of your account balance and your account’s floating P/L.

Equity = Account Balance + Floating Profits (or Losses)

Example: Account Equity When an Existing Trade  is  Losing

You deposit $1,000 in your trading account.

Beyoncé tweets that she’s shorting GBP/USD. Because she’s Beyoncé, you follow what she says and go short also.

Price moves immediately against you and your trade shows a floating loss of $50.

Equity = Account Balance + Floating Profits (or Losses)

$950 = $1,000 + (-$50)

The Equity in your account is now $950.Account Equity with Floating Loss

Example: Account Equity When an Existing Trade is Winning

Beyoncé tweets again and says she’s changed her mind. She’s now long GBP/USD.

Not only is she Crazy in Love, but she seems crazy in trading also.

Price moves immediately in your favor and your trade shows a floating gain of $100.

Equity = Account Balance + Floating Profits (or Losses)

$1,100 = $1,000 + $100

The Equity in your account is now $1,100.Account Equity with Floating Profit

Your account equity continuously fluctuates with the current market prices as long as you have any open positions.

Equity shows the “TEMPORARY” value of your account at the current time. (Unlike a tattoo, which is…not temporary.)

That’s why Equity is seen as a “floating account balance“. It will only become your “real account balance” if you were to close all your trades immediately.

What is the difference between Balance and Equity?

Let’s start with a simple answer.

If your account is “flat” or does NOT have any positions open, then your Balance and Equity are the SAME.

But if you do have open positions, this is when the Balance and Equity differ.

  • The Balance reflects your profit/loss from closed positions.
  • The Equity reflects the real-time calculation of your profit/loss. The Equity takes into account both open AND closed positions.

This means that when you’re looking at your Balance, it is NOT the actual real-time amount of your funds.

 

Since Equity includes current profits or losses from open trades, it is Equity that shows the real-time amount of your funds.

 

It’s possible to have a very large Balance, but very small Equity.

This happens when your open positions have a large unrealized (floating) losses.

For example, if your Balance is $1,000, and you have an open trade that has a floating loss of $900.

Your Equity is only $100.Account Equity with $900 Floating Loss

Recap

In this lesson, we learned about the following:

  • Equity is your account balance plus the floating profit (or loss) of all your open positions.
  • Equity represents the “real-time” value of your account.

In previous lessons, we learned:

  • What is Margin Trading? Learn why it’s important to understand how your margin account works.
  • What is Balance? Your account balance is the cash you have available in your trading account.
  • What is Unrealized and Realized P/L? Know how profit or losses affect your account balance.
  • What is Margin? Required Margin is the amount of money that is set aside and “locked up” when you open a position.
  • What is Used Margin? Used Margin is the total amount of margin that’s currently “locked up” to maintain all open positions.

Let’s move on and learn about the concept of Free Margin.

What is Used Margin?

In order to understand what Used Margin is, we must first understand what Required Margin is.

Whenever you open a new position, a specific amount of Required Margin is set aside.

Required Margin was discussed in detail in the previous lesson, so if you don’t know what it is, please read our What is Margin? lesson first.

If you open more than one position at a time, each specific position will have its own Required Margin.

Required Margin

If you add up all of the Required Margin of all the positions that are open, the total amount is what’s called the Used Margin.

Used Margin

Used Margin is all the margin that’s “locked up” and can’t be used to open new positions.

This is margin is already being “used”. Hence the name, Used Margin.

While Required Margin is tied to a SPECIFIC trade, Used Margin refers to the amount of money you needed to deposit to keep ALL your trades open.

Example: Open a long USD/JPY and USD/CHF position

Let’s say you’ve deposited $1,000 in your account and want to open TWO positions:

  1. Long USD/JPY and want to open 1 mini lot (10,000 units) position.
  2. Long USD/CHF and want to open 1 mini lot (10,000 units) position.

The Margin Requirement for each currency pair is as follows:

Currency Pair Margin Requirement
USD/JPY 4%
USD/CHF 3%

How much margin (“Required Margin”) will you need to open each position?

Since USD is the base currency for both currency pairs. a mini lot is 10,000 dollars, which means EACH position’s notional value is $10,000.