Free margin is the amount of funds available in a trader's account that can be used to open new positions or cover losses. It's calculated by deducting used margin and required margin for open positions from the account's total balance.
Let's delve into the concept of "Free Margin":
Margin can be categorized into two types: "used" and "free." We previously discussed "Used Margin."
Free Margin is the difference between your Equity and the Used Margin.
Another term for Free Margin is "Usable Margin" because it's the margin available for your use.
Free Margin serves two main purposes:
It represents the amount you can use to open NEW positions.
It indicates how much your EXISTING positions can move against you before you encounter a Margin Call or Stop Out.
For now, don't worry about the details of a Margin Call or Stop Out; we'll cover those later. Just understand that they're situations you want to avoid, akin to dealing with acne breakouts.
Calculating Free Margin is straightforward:
If your open positions are currently in profit, your Equity rises, and consequently, you have more Free Margin available.
When your open positions incur losses, your Equity decreases, resulting in less Free Margin.
Let's begin with a simple scenario:
You deposit $1,000 into your trading account, and you have no open positions. What's your Free Margin?
With no open positions, determining Equity is uncomplicated:
Equity = Account Balance + Floating Profits (or Losses)
In this case:
Since you lack open positions, there are no floating profits or losses.
If you have no open positions, your Free Margin is identical to your Equity:
In this scenario:
Since there are no open positions, no margin is "used." Thus, your Free Margin matches both your Balance and Equity.
Now, let's introduce a trade to make it a bit more intricate:
You start with a $1,000 account balance.
You plan to go long on USD/JPY, opening a position of 1 mini lot (10,000 units) with a Margin Requirement of 4%. How much Required Margin is necessary for this position?
Given that USD is the base currency, the Notional Value of this mini lot (10,000 units) amounts to $10,000. The Required Margin can be calculated as follows:
Assuming your trading account is denominated in USD, and considering the 4% Margin Requirement, you'll need $400 as Required Margin.
At this point, you only have one position open, so the Used Margin matches the Required Margin.
Assume that the price has moved slightly in your favor, and your position is now at breakeven. This implies your floating P/L is $0. Let's compute your Equity:
Your Equity is now $1,000.
Having determined the Equity, you can calculate the Free Margin:
Therefore, your Free Margin amounts to $600. In essence, Equity is also the sum of your Used and Free Margin.