Margin Level is an important indicator in trading. It represents a ratio between Equity and Used Margin on a trading account. Managing Margin Level allows for the mitigation of potentially crippling losses to both a trader and a broker (who lent money to the trader).
Margin Level is calculated as Equity divided by Used Margin on an account. In simple words, it is a proportion between the value on the account (Equity) and the trader’s funds deployed to open positions (Used Margin). The higher the margin level the more funds are available for a trader to make more trades.
Margin Level = Equity / Used Margin
Equity is the amount of Balance on a trading account adjusted by the floating (unrealized) profits or losses, often called FPL as an acronym.
Equity = Balance + FPL
Used Margin is how much of the trader’s funds out of the balance went into trading positions (essentially to collateralize them). The amount depends on the leverage used: the higher the leverage, the lower the amount of Margin is needed.
Let’s look at a hypothetical example:
You have a $1,000 on your balance and you open a position that uses $800 of your margin.
At the very start, since there are no profits or losses yet, FPL equals to zero and the equity on your account equals to its balance:
Equity = $,1000 + 0 = $1,000
Hence, Margin Level is 125%:
Margin Level = $1000 / $800 = 125%.
It means the value on the account (equity) will cover the amount of collateral (used margin) placed to support the existing positions.
Let’s imagine things do not go your way and your position incurs a loss of $500. That means, if you closed your position right now, your equity would drop to $500.
Equity = $,1000 - $500 = $500
Margin Level = $500 / $800 = 62.5%.
Not only you do not have any more available margin to open new trades, but you may also be nearing a possible liquidation of your position to mitigate further losses. If your position keeps losing, you may run the risk of running out of funds. Margin calls are meant to alert a trader about those situations.
In case of a Margin Call, trader needs to decide a further course of action. He may do nothing and accept the possibility of involuntary liquidation when margin reaches a certain (predetermined) level. Or he may reassess strategy by either increasing Equity (to avoid involuntary liquidation of a position) or closing the position and absorb a loss (to avoid further losses). It is important to monitor Margin Level and make appropriate strategy adjustments if it nears Margin Call levels provided by the Broker.