Initial margin is the amount you have to pay a broker to open a trade on the forex market. It’s worked out as a percentage of the total value of your trade.
Imagine you wanted to start trading on the forex market.
For this to happen, you’d need to open an account with a forex broker and deposit initial margin.
The broker decides how much initial margin you have to pay, and this can vary from one broker to another. So, if you wanted to trade $5,000, for instance, and the broker set initial margin at 10%, you’d have to deposit $500.
It’s helpful to think of initial margin as a security deposit. The broker sets it aside, and, if the market doesn’t go your way, they’ll use it to cover your losses. In exchange, you can speculate on foreign exchange transactions for a fraction of the capital you’d normally need.
Let’s say you wanted to speculate on the value of the Euro going down against the US Dollar. You have $5,000 to invest.
If you went to a traditional foreign exchange broker, you’d need to deposit the full $5,000 up front.
In comparison, if you trade on the foreign exchange market, you only need to deposit initial margin. The broker will “lend” you the rest.
So, if the broker set initial margin at 20%, you could deposit $5,000 and the broker would lend you $20,000, bringing your investment up to $25,000. If the exchange rate moved in your favour, you’d pay back the $20,000 and pocket the difference. This is called leverage — using debt to purchase an asset, in this case foreign currency.
Trading on margin can help boost your profits significantly, even if the market moves only slightly in your favour.
The flipside, of course, is that if the market doesn’t go your way, your losses will also be much bigger. To use our previous example, if the exchange rate moves against you and your trade’s value falls from $25,000 to $15,000, you’re on the hook for the full $10,000, not just the $5,000 you paid to open the trade.
Some Facts
- Alongside initial margin, you may also have to deposit maintenance margin. As the name suggests, maintenance margin is the minimum amount you need to deposit into your account to keep — or maintain — your trading position open. Let’s say you deposited $5,000 on a $25,000 trade. The market goes against you and you lose $200. This means the funds in your account are now lower than the initial margin your broker requires. To keep the trade open, you’ll need to deposit a maintenance margin of $200 to bring your balance back to $5,000.
- Brokers continually monitor your account and will alert you if you need to deposit maintenance margin. This kind of alert is called a margin call.
- Some brokers increase their initial margin requirements at weekends. This is because exchange rates can fluctuate more suddenly and widely if something happens that could affect their value — a government collapsing, for instance — while the markets are closed.
Want to know more?
- This video dives deep into margin requirements and their impact on the size of individual trades.
- Wondering how margin works in practice? This trading calculator lets you calculate initial margin, how much leverage you could get, and how much profit you could potentially make on a trade.
ALT21’s perspective:
“Trading on margin can have a huge impact on your finances, so making sure you understand the concept and how it influences your trades is crucial. As much as you can use margin to get leverage and amplify your profits, it can also go the other way and amplify your losses, so it’s best to approach with caution.”
