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Margin vs. Free Margin: Overview, Similarities & Differences

TABLE OF CONTENTS

Margin vs. Free Margin: Overview, Similarities & Differences

Margin vs. Free Margin: Overview, Similarities & Differences

Vantage Updated Updated Thu, 2022 August 18 07:55

‘Margin’ and ‘free margin’ are two critical aspects you must understand to trade the markets. Understanding these terms helps you figure out how your broker views your investment and how you can manage your account as a result.

Knowing the difference between the two will also help you execute your trades with greater precision while protecting your capital from misuse.

In this article, you’ll learn the meaning of both margin and free margin, their synonyms, and how you can apply and use them in your trades.

What is Margin?

Margin (also known as capital) is the minimum fund you need in your brokerage account to make trades. Your broker uses margin to guarantee your ability to open new positions and maintain them [1].

Most times, your broker will give you access to leverage, and your margin will allow you to control larger positions even with limited capital. In the trading world, this is also known as trading on margin.

Essentially, margin is the funds you deposit into your brokerage accounts to open trades. It also represents a fraction or percentage of the trading account’s funds to keep all your active positions open.

Please note that margin requirements vary from broker to broker. Therefore, it is critical to look out for it when picking your broker.

So, what does margin look like? Here is an example:

Suppose you have a trading account with broker X, who’s offering leverage of 400:1. That means you need 1 unit of your funds as margin to control an open trade worth 400 units. Therefore, you only need $1 to control a trade position worth $400.

Essentially, your margin requirement with broker X is 0.25%, equivalent to 1/400.

What is Free Margin?

Free margin is the difference between the actual value of your trading account (equity) and the funds distributed to keep your open positions active. Free margin is the unused portion of your total margin that lets you open new positions at any given time [2].

Your free margin will include any gains or losses that result from the movements of your open trades.

To know how much free margin your account has, you first need to understand the difference between your account’s equity and your total used margin.

So, what’s equity?

Equity

Equity is the total amount of funds in your account, and this includes your deposit and the used margin from all your open trades. If you don’t have any open trades, equity is the total capital available in your trading account [3].

So how does equity relate to free margin?

Free margin will increase or reduce depending on the performance of your active trades. If your open positions move against you, any loss you incur directly impacts your free margin – the funds available to make new trades. Any potential gains on your open positions will positively impact your free margin, too.

Besides giving you extra funds to leverage in new trades, free margin cushions you against unpredictable moves in any of your open positions. That way, you won’t get stopped out of your positions and get a margin call.

In case your margin level drops, you’ll receive a margin call. At this point, your account can no longer guarantee any open or any new positions you may enter. To continue trading, your broker will require a new deposit to your account or they may close any open position you have.

To increase your free margin, you can top up your trading account, exit any open positions, or wait for any or all of your current positions to make gains.

The acceptable margin level is 100%. You can calculate this by taking your equity value against the used margin and multiplying it by 100.

For example, when your account value stands at $15,000, and you have put $6,500 to use, your margin level is 15000/6500 X 100 = 230%.

To better understand what free margin is, let’s use the following example:

Example 1:

Let’s say you have an equity of $1,000, and you take a $350 open trade. What is your free margin?

The formula for free margin is:

Free margin = Equity – Used Margin

From the example above, your free margin is:

$1000 – $350 = $650.

Example 2:

Suppose you have an account balance of $15,000 and need to buy 3 lots of GBPUSD at an exchange rate of 1.26000. What is your free margin assuming your broker has given you leverage of 100:1?

So, without any leverage, you’d require $378,000 (300,000 X 1.26000) to buy 3 lots of the GBPUSD pair. But since you’re using leverage, you don’t need to put up such a huge amount of capital.

Instead, you require a margin of $3,780 to control such a trade. We get that by dividing $378,000 by the leverage of 100.

Also, suppose you make an accurate prediction, and the GBPUSD price shoots to 1.28750. Your open position now has a positive gain of about 0.0275 pips (1.28750 – 1.26000).

This is an equivalent of $10,395 ($378,000 X 0.0275).

Now, based on the free margin’s formula, $15,000 + $10,395 – $3,780 = $21,615. You would have $21,165 in free margin in your account.

Similarities between Margin and Free Margin

The terms margins and free margins have a close relation. These are some similarities:

  • Free margin is part of your entire margin
  • Margin and free margin both go into financing your positions
  • If your positions have a positive gain, that increases both your margin and free margin. Depositing more funds to your account has the same effect.

Differences between Margin and Free Margin

Here are the differences between margin and free margin:

  • Margin is the amount of funds you deposit with your broker to guarantee your open trades. On the other hand, a Free Margin is the size of equity in your trading account that you can use to get into new positions.
  • You cannot withdraw margin, which is locked in open positions, but you can withdraw free margins that are the unused equity you can access for personal use.

Final Word

Knowing the difference between margin and free margin can go a long way to helping you manage your capital. With free margin in your account, you can take more positions and still maintain your account without over leveraging.

Reference

  1. “What Is Margin?”. Investopedia, 2022, https://www.investopedia.com/terms/m/margin.asp.
  2. “What Is Free Margin”. Babypips, 2022, https://www.babypips.com/learn/forex/what-is-free-margin. Accessed 16 May 2022.
  3.  “Equity”. Investopedia, 2022, https://www.investopedia.com/terms/e/equity.asp.

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