Understanding margin in prop trading: A beginner’s guide

For traders wishing to advance their abilities, prop trading businesses are a common choice. In order for traders to succeed in the markets, these companies offer them funds as well as cutting-edge trading tools. But, traders must comprehend margin and how it functions in order to trade with a prop business. The amount of money a trader must deposit with their broker in order to open a position is known as margin. It protects investors from possible losses and enables trading with larger sums of money than are available at the time. Margin is used by prop companies to enable its traders to trade with larger positions and boost their potential profits. Margin is merely a portion of the account’s balance that the company locks in when we start a new position. Leveraged trading is the practice of investing only a percentage of trader’s capital, and it enables traders to take much greater positions than we could otherwise afford. Because of this, traders can generate significant returns even when market changes are modest. Margin use involves fees because it is a type of borrowing money, and the account’s marginable securities serve as insurance. 

Why is leverage used in Prop trading?

The majority of the time, traders use leverage when they trade the markets. Leverage is a loan given to the trader by the broker. Fundamentally, the capacity to control a huge quantity of money using neither much nor any of trader’s own money and borrowing the rest can be summed up as having leverage. The higher the ratio used to describe leverage, the more leverage the trader has. For instance, if a broker offers a leverage ratio of 100:1, it indicates that trader’s can trade up to $100 for every $1 in the account. Instead of directly holding the underlying assets when trading, traders speculate on the price movements of the markets and underlying assets in the pursuit of a profit. When traders use leverage, it means that the prop firm is putting up the majority of the money, and the trader is paying a fee to hold the account and be capitalized. Leveraged stock trading, for instance, entails opening a position with a prop firm and borrowing most of the position’s value amount from that prop, depending on the leverage ratio. 

The use of Margin in Prop Trading

The amount of money locked depends on the broker or firm’s margin requirements. When traders open a trade, the required margin, sometimes referred to as entry or initial margin, is expressed as a percentage that represents funds as a percentage of the overall amount. Opening a position of 1 lot size (usually $100,000 in forex) on the GBPJPY pair when the needed margin is 1% will block $1,000 in the account. Ideally, traders ought to have $1000 USD or more in the account. In this instance, the leverage is 100:1. It is significant to keep in mind that the needed margin (and, consequently, leverage) differs from firm to firm and that different investment vehicles have varied margin requirements. More funds are blocked in the account with each new trade traders make when they establish new positions. The utilised or total margin is the total amount of money. Available margin, also known as free margin, refers to the remaining cash that traders currently have accessible. Hence, it is the account’s equity (balance, as adjusted by the profit or loss on open positions), less the margin needed.

The value of preventing margin calls

Traders margin level may dramatically decline if they take on too many huge positions or if their open trades suffer severe losses. Traders receive a margin call when it reaches a specific level, indicating that our equity has dropped below the amount of the used margin and that there aren’t enough funds in the account to cover the required margin. There is no automated closing of positions during a margin call at this stage, so traders must either start closing our open positions and stop opening new ones, or traders must add additional money to the account. Traders can reach a point known as a stop-out if they keep underperforming and the margin keeps decreasing as a result of the unfavorable market performance. Each broker or prop firm sets this level in a unique way. Nonetheless, the prop firm will begin closing the open positions when this amount, for instance, reaches 50%. The trades with the biggest losses are closed first because cancelling a single trade can result in margin levels exceeding 50%.