We have already discovered in a previous article that Margin is the amount of money needed to open a trade, and once trades are opened, we can see the total amount of Margin being used in the terminal window of the trading platform. For a recap on Margin click here.
When trades are open, the platform will also clearly indicate the Margin Level, represented as a percentage it is the relationship between the Equity and used Margin in the trading account. To read our article on Margin Level click here.
We also saw that if the Margin Level on the trading platform dropped to 80% this would trigger a Margin Call as a warning that the funds in the account are running low. Subsequently if the Margin Level continued to fall further, at 50% this would trigger the Stop Out in an attempt to protect the account from going into negative balance. Click here for further reading on Margin Call or here for Stop Out.
So, what is Free Margin?
Quite simply, Free Margin refers to the amount of money available in the trading account to open trades with. It is the difference between the Equity and Used Margin on the trading account and is calculated using the following formula:
Free Margin = Equity – Margin.
If you were to have open positions in the trading account that were currently profitable, this would increase the Equity which in turn would increase the Free Margin.
If however you had open positions that were currently loosing money, this would decrease the Equity and in turn reduce the Free Margin.
To see how this works in practice, let’s look at an example:
Assuming we have a trading account with a 10,000 USD balance and no open positions, we can use the above formula to work out our Free Margin.
Step 1 – Calculate Equity:
Firstly, we need to work out our Equity. If we have no open trades this is easy as Equity = Balance + Credit + Profit/loss + Swap + Commission, So 10,000 = 10,000 + 0 + 0 + 0 + 0.
In this case our Equity is the same as the Balance.
To read our article on Equity please click here
Step 2 – Calculate Free Margin
Now we know our Equity we now need to know our Used Margin. As in this example there are no open positions the Used Margin will be 0.
Using the formula Free Margin = Equity – Margin.
Our Free Margin = 10,000 – 0 = 10,000 USD
Let’s now look at an example with an open trade.
In the same 10,000 USD account let’s open 1 lot on USDJPY. As the USD is the base currency in this pair 1 lot = 100,000 USD.
Step 1 – Calculate Required Margin
Assuming the Margin requirement on the USDJPY is 1%, we can use the following formula to calculate the Required Margin:
Required Margin = Trade size (in units) x Margin % or Trade size (in units) / Leverage
So, the Required Margin needed to open the trade will be 100,000 x 0.01 = 1,000 USD
Step 2 – Calculate Used Margin
As we only have one open trade in this example, our Used Margin will be the same as our Required Margin.
Step 3 – Calculate Equity
For this example, let’s assume that since opening the trade the price has moved slightly into our favour causing the position to be at break even meaning the floating Profit/Loss is 0.
Using the following formula, we can calculate the Equity = Balance + Credit + Profit/loss + Swap + Commission
Equity = 10,000 + 0 + 0 + 0 + 0
The Equity on the account is 10,000 USD.
Step 4 – Calculate Free Margin
Now we know the Equity and the Used Margin we can calculate the Free Margin with the following formula:
Free Margin = Equity – Margin.
Free Margin = 10,000 – 1,000
So, the Free Margin is 9,000 USD
To see in real time how the Free Margin changes in the account, why not open a Demo account here on our website an open some risk-free trades.