Understanding Contract Sizes

Understanding contract sizes (lots) is a necessary precursor to understanding the need for high leverage in the Forex market. Each standard lot traded in the Forex market is a $100,000 contract. In other words, when trading one lot in a standard account, a trader is essentially placing a $100,000 trade in the market. Without leverage, most investors would not be able to afford such a transaction. Leverage of 100 - 1 would allow a trader to place the same one lot ($100,000) trade with the post of $1,000 in margin. $100,000 divided by 100 equals $1,000, thus 100 - 1 leverage means that $1,000 of margin is able to control a $100,000 position.

Many retail Forex traders today begin their trading in a Mini account. Because standard contracts in the Forex market are rather large, even with 100 - 1 leverage, $1,000 of margin per contract traded is still a bit expensive for some investors. For this reason most retail brokers offer the option of a mini account.

Mini accounts are essentially 10% the value of standard accounts, meaning that mini contracts are $10,000. A trade of one mini lot would be a $10,000 trade, whereas a standard lot is of course a $100,000 trade. It is not unusual for brokers to offer higher leverage in mini accounts, 200 - 1 is very common. Trading with 200 - 1 leverage would mean that $50 of margin would control a $10,000 contract

Calculating Margin

Margin is calculated 2 ways: Used Margin and Free Margin. Used margin is the amount of money used to hold open positions. Free margin is the amount of funds available to place additional positions

As seen in figure 1, $250 is used to hold their current positions, totaling 5 mini lots. $4,736.00 is available for the trader to open additional positions.

Calculating a Margin Call

Because institutions are loaning 99% of the value of a contract to a trader, fail-safes have been put in place to help prevent a trader from going into the negative and owing the institution additional funds. This is commonly referred to as a Margin Call, where typically a client is called upon to send additional funds or the position(s) will be closed at market price. At 50% margin level the trader will be subject to a margin call, the automatic close of open positions so as to bring the margin level back to a suitable percentage.

The margin level is calculated by dividing the current equity in an account by the current amount of margin in use (used margin)

After dividing the equity by the margin move the decimal two places to the right. A trader whose equity is at $1,000 and who is using a $500 of margin would divide 1,000 by 500 which of course equals 2. Then move the decimal two places to the right; this trader's current margin level or percentage is thus 200%. At 100% margin level a trader is essentially using their entire available margin. When this level drops to 50% trades will automatically be closed to help ensure that a trader is not subject to losing more money than is held in their account.