What is a Free Margin? And how does it work in forex trading? It is very important to understand all the parameters and the terminologies used in trading. It is without a doubt one of the significant factors that point to a trader’s capability in opening new positions, and the management of open positions generally. Since free margin is a fundamental aspect in the trading environment, traders who lack understanding of what free margin entails and the role it plays could end up making wrong decisions, thus causing them to lose lots of cash. 

What is Free Margin? How Does it Work in Forex Trading?

Free margin is the money that the trader has that he can use for opening new positions. It is arrived at by deducting the current margin which has been applied to the opened positions from the trading account equity. In layman’s terms, therefore, it is the amount of money that is available in your account that is not locked and can be used to fund new trades or meet any loss-making trades.

In Forex trading, It is like an added cushion that ensures one’s account never runs into the red zone. If you are to open a position, you dedicate a certain amount within your account balance as used margin while the rest is the free margin. Since the price changes as a function of time, the value in the open positions alters too affecting the free margin. In other terms, when your positions turn into profit, your free margin rises in a reverse manner and vice versa.

Relationship Between Free Margin and Equity

Free margin is all the time concerning the account equity always for a trader. Account equity means the current balance in your account plus open profit/losses or unrealized profit/losses. 

Free margin is found out by the following formula: used margin/equity. 

Therefore, the free margin will vary with the changes in equity. Should your positions be and so does your free margin. On the other hand, if your positions are in loss your equity reduces hence your free margin is lower.

The Calculation

In Forex trading, calculating a free margin is crucial information. Although it is straightforward, you can see it affects how a person decides to approach a trading session.

The formula:

Free Margin = Equity – Used Margin

Where:

• Equity = Account Balance + Unrealized Profits (or – Unrealized Losses)
• Used Margin = The total margin currently tied up in open positions

Step-by-Step Calculation

1. Determine Your Account Balance: An account balance in trading is the total amount of cash available in the trading account that is not committed to an open position.
2. Calculate Equity: Add any unrealized profits or subtract unrealized losses from your account balance. This gives you your equity.
3. Identify the Used Margin: The used margin is the amount of money that has been allocated by your broker for your trades and the open positions.
4. Apply the Formula: Free margin = equity – used margins.

Examples In Calculation Using Different Strategies

• Scenario 1: Low Leverage, Conservative Trading

Account Balance: $10,000

Open Positions with a Used Margin of $1,000

Equity (Assuming no unrealized profit/loss): $10,000

Free Margin = $10,000 – $1,000 = $9,000

• Scenario 2: High Leverage, Aggressive Trading

Account Balance: $10,000

Open Positions with a Used Margin of $8,000

Equity (Assuming no unrealized profit/loss): $10,000

Free Margin = $10,000 – $8,000 = $2,000

How to Monitor and Manage Free Margin

• Use Trading Platforms with Real-Time Margin Tracking: Almost all trading platforms provide features whereby one can track the real-time free margin. 
• Set Alerts: To minimize margin calls one can use stop-out alerts which efficiently inform the trader that the free margin has fallen below a specified level. This can enable you to intervene before your broker does so, an action that may see you lose out.
• Adjust Your Leverage and Position Size: If it is an issue that is constantly running low you may perhaps cut down your leverage or the size of your positions. It may enhance your free margin and should minimize the probability of margin calls.
• Avoid Overtrading: When multiple positions are used, the free margin can be spent very fast, if more positions are opened at once. When trading, do not make too many trades as this will put lots of pressure on your account.

The Correlation

The process is not complicated, and yet, it just as much may influence your trades and strategies dramatically.

1. What is a Margin Call?

Margin call is a specific event when the free margin of a particular trader is at a certain level, that is why a broker requires the trader to bring more money or to close certain positions. This is done to safeguard the trader and the broker from further losses MORE THAN the account balance.

2. The Relationship

It can be considered being the ‘cushion’ that protects you from margin calls. When you reach a free margin that will be zero, then a margin call hits your account. However, if your positions keep on giving adverse price movements, your broker can start to close out your positions to restore acceptable margins. 

Frequently Asked Questions

1. What is the difference between free margin and used margin?

Free margin is the total volume of usable margin in your trading account without which you cannot open a new position. 

Used margin, on the other hand, refers to the portion of your account equity that is already allocated to maintain your open positions. 

2. How does free margin affect my ability to open new trades?

It additionally enlightens one on the number of positions that one may open. It is the amount of money you have on your account after subtracting used margin which is used for maintaining open positions or for opening new ones; if your free margin is low, you will not have enough funds to meet the requirement for other trades; thus, you will not be able to exploit certain market conditions.

3. Can free margin go negative, and what does it mean?

It can turn negative in case your open positions are negative and you have less equity than the used margin. This means the value of your margin account starts declining and when this happens, you can receive a margin call from your broker who may close some or all your positions to avert further loss.

4. How can I increase my free margin in my trading account?

• Closing losing positions: This frees up the used margin tied to those trades.
• Reducing leverage: Lowering leverage decreases the margin requirement for open positions.
• Depositing additional funds: Adding more capital to your account increases your overall equity.
• Managing risk more effectively.