Equity & Margin What This Is ? Forex For Beginner’s Guide


Equity and margin in the previous tutorial we explored an example where we were opening a hypothetical order of a zero point one lots. Now to create this transaction we required twelve thousand three hundred twenty two dollars. And because that was quite a substantial amount. We explored the concept of leverage and in fact we found that with a leverage of 1 to 100 we could borrow 99 percent of the required amount from the broker and we would only be required to put in 1 percent or $123 know that amount that we need to put in the $123 is called the margin for this transaction. And today we’re going to talk more about the margin and find out exactly why the broker is willing to lend us 99 percent and how leverage works in the background and how all of these concepts play out. When you open an order and when the market goes against you and when the market goes in your favor. So let’s jump straight into it. So here is our $500 balance and now we want to open that transaction which we talked about. So the broker puts in twelve thousand one hundred ninety nine. We put in $123 or the $123 is on margin and the remaining funds. So the 500 minus the 123 The $377 that is called the free margin. Now here we are going to introduce one more concept and that is the concept of equity. Now normally equity is defined as the balance on your accounts plus or minus any unrealized profit or loss. So basically your balance is constant until you actually close your transaction but your equity reflects whether the market is going in your favor or it’s going against you. However in this example to start off we’re going to kind of introduce equity backers we’re going to introduce equity as the free margin account plus the margin. There’s no big difference and you’ll see just in a few moments how that is exactly the same as what we discussed about balance and unrealized profit or loss. So there’s our equity. We’re going to outline it with a green bracket here on the right. And now let’s see what happens as the market moves in either direction. So we start we’ll start off with by looking at what happens when the market moves against us. So if the market moves against our position then first of all let’s say it moved in against us and the unrealized loss on our account is $100. So as you can see the margin is intact. The broker funds are intact but the free margin has reduced by $100 and therefore our equity has also reduced by $100 at the same time. We should note that the balance hasn’t changed so that big box the overall box is still $500 and still we it looks like we have $500 on our call because that’s our balance. But in reality there is an unrealized loss and it’s cold and unrealized loss because you haven’t yet closed the transaction so that you know that loss might change into a profit of time or that might increase as a loss. So if the market keep keeps going against us now the free margin has reduced by $200 and the equity has reduced by two hundred dollars. And at the same time the borrowed funds and the margin of the frozen margin are still intact. Now what happens if the market keeps going against us. Well what will happen is a stop shot so a stop out is when the broker sees that you have lost quite a lot of funds and you don’t have any free margin left. And in that case the broker will automatically close your position and you this loss will become a realized loss. And that way they will be able to pull out of this position. So because they lent you some money and now they see that the position has gone against you they don’t want to lose any of the money that they lent you. So they’re just going to close your position and pull out their 12000 199. And in this case the margin acts as a safety net or a safety buffer. So basically the brokers saying OK this trader doesn’t have any free margin left. We should close the position and in that case what will happen is they pull back the 12:1 twelve thousand one hundred ninety nine and you get back your margin so your margin is returned to you. So why does a broker use this margin as a safety buffer. Well because while they’re closing the transaction the market can actually move and they might not have enough time to close the transaction spot on on that margin level so the market might even move a bit further against you and might ease into your margin and you won’t get $123. You might get $100 back $90 back or $150 back. So that is their safety buffer so that is the funds that will get eaten into before the funds that they actually enter you. So that’s how the broker uses the margin as a safety net. And as you can see the equity has also reduced the size of the margin. Now the Stop can happen at when all of your free margin is eaten up so when you only have margin left or maybe when you have half of your margin left so the broker might in its terms and conditions specify that it will allow 50 percent of the margin to be used up before the stop out occurs or it might allow 70 percent of the margin to be used up so you have to refer to the terms and conditions of your broker to understand at which point to stop our worker. And another thing you should be aware of is that sometimes will also be a margin call some margin call normally occurs before a stop out and it’s a warning from the broker telling you that you’re getting very close to stop out level and you should intervene and do something about it. Now it’s not necessarily going to happen you’re not necessarily going to have a margin call and in fact a lot of brokers might have the margin call set at the same level as the stop out. So basically the margin call won’t happen because it’s too late anyway. The stop that has occurred so that’s another thing you should look into and check with your broker chiken the terms and conditions or the product disclosure statement and find out when does is there a margin call when does that occur. When What’s the levels to the top. Also occur at. OK. So that’s what happens if the position goes against you. Now let’s see what happens if the person goes in your favor. Back to the start of a kid on the right free margin and margin and let’s say you have said a take profit somewhere up at the top over there where the dust or the dotted line is. Now if the position moves in your favor so here we can see that we’ve earned some money as you can see your position still isn’t closed. Your balance is still $500. What’s your free margin has increased. So any unrealized profit or loss is being added to your free margin and therefore as you can see your equity is increasing and that’s a good thing because now you can use this free margin to happen more transactions if you wish to do so. But we’re not going to go into that. Let’s continue with this example so your free margin is increasing your equities increasing and the market keeps moving in your favor and it hits you take profits Horray your free margin has increased your equity has increased at the same time you can see that the margin is still the same $623 and the amounts of money that you bought from the broker hasn’t changed still 12 199. So what happens next is your position closes. The broker pulls back their amount. So they take back their 12 199 and your margin is released and it is added to your back to your account . So it was always on your call but now is released and it’s no longer frozen margin. So now your balance is $763. So as you can see here that is one of the great advantages of leverage is that the broker just at the end when the transaction is complete all the broker wants back is the money it lent you. They don’t want none. They’re all going to penalize you for using leverage and therefore you get to keep all of the profits you made. So even though you borrowed money to open this transaction you get to keep all the profits you make . The downside of course is that in your losses you make are also going you’re going to be liable for any of those losses that you make. So there we go. That’s how our leverage works. And in a way it’s kind of like a magnifying glass to find leverage you can only conduct if if you can if you even have enough balance to conduct the smallest transactions on like micro transactions on the forex with leverage. Everything is magnified so you can conduct greater transactions you incur greater profits or and at the same time you will incur great losses if they occur. And you only have that amount of money that is on your account to accommodate those losses. So since your money runs artisan’s your free margin runs out. The broker will pull their funds back. So in a way I like to think of the leverage as a sportscars So of course you can hurt yourself by driving a sports car. But if you know what you’re doing and if you’re careful about it and you’re just driving it safely then you can derive substantial benefit from it. And same thing with leverage of course you can hurt yourself and there are substantial risks associated with leverage. But on the other hand if you know what you’re doing if you calculate your risks and if you’re careful about it then you can derive substantial benefits from having that leverage. All right so that’s how leverage works. And before we conclude this tutorial I’d like to highlight one more important key risk associated with leverage. So I’m going to go back to our example here and let’s go back to the example where the market goes against us. So sure you can see that there is a stop out which kind of is a safety net for the broker and etree . After the stop what happens you get your margin back. The broker gets the amount that it lent you back. And that’s the end of it. However sometimes it so happens on the forex market that the movements can that caused your position to go against you. That can be so quick and so volatile so it can be such an big movement that the broker might not have enough time or might not have an opportunity. They might not be a price in the market for your position to be closed at the stop on. So the broker is intending to close it but are just not able to do it. So in that case as we discussed your margin will start to suffer and the funds will be any additional losses will be taken out of the margin and that way your margin is like the little safety buffer between your funds your free margin and the brokers funds the ones that they lintian. But at the same time if that market movement is so drastic and so quickly that it actually shows up through all of your margin then what will happen is that before the broker is able to close the position the brokers funds will start to suffer so the market will start eating into the 12 199 that the broker lent you in this specific example. So and that is an additional risk. So if the market moves so quickly that it eats up all of your margin and it uses up some or even all of the money that the broker lent you then you should be aware that you will be liable for those funds that were used up from the money that the broker lent you. So you need to check the terms and conditions. But there’s is a very high chance that you will be liable for those funds. And the broker can reclaim them back from you. So the broker can ask you to pay back that money so be careful of that. That is an inherent risk of using leverage. And of course this risk is has to be verified with your broker has to be checked if your terms and conditions . But you should make yourself aware of that and you should understand this risk when you’re using leverage . So I just wanted to make sure that you’re aware of that. And that brings us to the end of today’s tutorial. There we go. Talked about equity and margin. And hopefully now you have a very clear understanding of how leverage works and why exactly brokers are willing to lend to that money. OK. I look for the next tutorial. And until then happy trading

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