What is Lotsize or Position Size in Forex?
Lot size is the amount or the trade volume unit. How much about of money a trader will invest for trading an currency pair or instrument. The number of currency units trader will buy or sell. Following table explains the details of the units for traders to understand.
Lot Size Value
Position Size in Unit
Example suppose a trader wants to buy EURUSD with a standard lot of 1.00 (100,000 units). Now we will calculate the pip value for his trading. EURUSD at an exchange rate of 1.2510: (.0001 / 1.2510) x 100,000 = $7.99 per pip. Here 100,000 units means 100,000 US Dollar.
What is Forex Leverage?
Leverage is the amount of money which traders borrows from the broker in time of trading any instrument. With Forex Trading, a trader with higher leverage can control the bigger amount of money in the time of trading. Leverage gets calculated based on instrument margin requirement & trader available account balance.
Based on the previous example, in order to buy EURUSD with 1 standard lot, trader controls 100,000 USD value. But if traders have $1000 in his trading account, that means need to borrow rest of the money from the broker, in order to continue trading. He needs to borrow at least 100x amount of money of his trading account deposit. It by forex term get denoted as leverage of 1:100. Leverage always get denoted with “:” sign.
If the trader had $100,000 dollar in his trading account, then account leverage will be 1:1.
Why Leverage is a Double-Edged Sword?
Just think you are controlling $100,000 value of trade with $1000. Each pip worth $7.99. If EURUSD moved 100 pips in your favor. Then you will earn $7.99*100 = $799, almost 79.9% of your trading account balance. Leverage is the reason why forex trading is so famous. Most of the trader thinks is a quick rich scheme. But think the opposite, if the market moved 100 pips against you, then you will lose 79.9% of your investment. Will it be nice? Of course not.
So higher the leverage is you can trade higher lot size with the lower amount of money. Thus if you make a profit you will earn great reward but if you lose the trade you will lose most of your investment. Lower leverage is always recommended with a larger amount of deposit or trading account size.
What is Forex Margin?
The margin is the security money deposit of trader in order to borrow money from the broker with leverage. With the example above, where you were trading $100,000 position with $1000 deposit & 1:100 leverage. That $1000 deposit is the margin money. The broker is not going loan you the money without any security deposit, which is pretty obvious for any kind of lending.
In order to open trade with certain trading lots for certain currency pairs, you need to calculate margin first based on your account balance. Margins are usually get counted with percentage based on account deposit. A broker generally requires 2% margin for opening orders with 1:50 leverage.
Example, you have $1000 in your trading account. If you want to trade 1 standard lot of EURUSD, controlling $100,000 position. Then you need to have $1231 in your trading account balance with 1:100 leverage.
If you choose 1:500 leverage (higher risk) then you will only need $246 account balance to trade $10 per pip of EURUSD.
This amount is known as “Margin Required”. “Account Margin” is the term which indicates total available money on your account. “Used Margin” is the money which is currently locked into your open trading position.
For example, if you had $500 trading account & with an opened trade of GBPUSD with a margin of $300. Then that $300 is the “Used Margin”.
“Free Margin” or “Usable Margin” is the amount of money is available in your account in order to place a new trade.
What is Margin Call in Forex?
Margin Call occurs when current open position value crossed your available free margin, or when you do not have enough money on your trading account to open a new trade with preferred lot size.
If an open position value exceeds the free margin, free margin goes into minus mode, then the broker will automatically close your trade & you will receive margin call notification. In order to start trading account, you need to deposit money. When you will receive a margin call, if you still need to continue trading, then you can trade in lower lot size with the rest of the small amount of money.
Receiving a margin call for a trader is a bad reputation for his/her trading performance. A good trader should never come into this situation & always take care of his/her account with lower risk.