Understanding trading fundamentals is essential for making better decisions and boosting your earnings on the foreign exchange market. If you’re a trading newbie, you’ve probably already heard about margins and free margins — both terms are often grounds for confusion. In this guide, we’ll explore margins, discuss negative free margins and their consequences, and how to avoid them in the first place.
Table of contents
Margin and Free Margin in Forex Trading
What is the difference between margin and free margin? Margin is the money you need in your brokerage account to enter a trade. Essentially, the capital guarantees your ability to open and maintain a trade. Keep in mind that =margin doesn’t represent a transactional cost or fee but is more of a security deposit. Forex margins are typically expressed as a percentage of the total position value and depend on the brokerage firm. Margins are often divided into:
- Used Margins. Funds are currently used as a security deposit to sustain an open position.
- Free Margins. The remaining funds in your account are left to open new trades. Free margin Forex is the funds not involved in transactions or tied up for the current open position.
With ‘Whats free margin in Forex’ out of the way, you may wonder why Forex brokers need it in the first place. The answer is simple: margin guarantees traders have enough funds to cover the transaction.
What Does It Mean When Free Margin Turns Negative?
If your open positions start bleeding money, they will drag down your equity as well. On the other hand, if your open positions start bringing in profits, your equity will skyrocket, leading to more free margins. A negative margin occurs when the trader lacks a margin to open trades and the account balance falls below zero. This situation is risky because it can result in margin calls — a demand by a broker to deposit extra funds in your account — or account liquidation.
Luckily, there are a couple of ways to turn the situation around and increase free margin:
- Add extra funds to your account;
- Close some of your profitable positions or reduce the overall position size.
Tip: If you want to maximize your potential and trade round-the-clock, expert advisers — algorithmic trading tools that minimize emotion-driven trades and automate your work — are a good place to start. For more information, check https://forexstore.com/best-forex-robots.
Consequences of Negative Free Margin
Is negative margin in Forex a disaster, and what are the consequences of traders lacking free margin to open trades? The answer depends on the severity of the situation. For instance, among the most common scenarios of free margin turning negative is the loss of funds. The broker may need to sell the trader’s assets to recover some losses. In the worst scenario, if the value of the remaining assets is lower than the scope of the losses, the broker will hold the trader accountable. In the most drastic circumstances, there is a chance of bankruptcy or legal action.
Why Margin Turns Negative: Common Scenarios
Multiple scenarios can lead to your equity suffering losses and your margin turning downward. Many cases stem from bad trading and common trading mistakes, like misunderstanding the trading fundamentals or taking more risks than you can afford.
How to Avoid Negative Free Margin
There are a couple of preventative measures that will minimize the chances of ending up with a negative free margin, as well as dealing with all the potential ramifications. Some of the most common pieces of advice include:
- Understand the fundamentals. Learn how equity and margin work, study the basics of Forex trading, and consider the margin requirements for specific trades.
- Have a solid plan. Risking more than you can lose is a bad idea, regardless of the industry you operate in.
- Consider stop-loss orders. Stop-loss limits your potential loss. Essentially, it’s a pre-set restriction automatically triggered when a price reaches a certain threshold.
Summary
Understanding basic concepts like free margins is essential for successful trades and preventing a negative margin. Learn to manage risk better, boost your trading strategy, and uphold the general mantra that saved many people from bankruptcy: never risk more than you can afford to lose.
