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Changes in your margin balance determines how much you can trade and

Â for how long you can trade if prices move against you.

Â So let's understand margin balances and liquidations.

Â When you open a currency trading account, which is mostly online these days,

Â especially for new investors like you and me,

Â you will need to put cash as collateral to support the margin requirement.

Â And the margin requirement is established by a broker.

Â That initial margin deposit becomes your opening margin balance and

Â is the basis on which all your subsequent trades are collateralized.

Â 1:31

Like in futures markets or margin based equity trading,

Â forex brokerages, most of them do not issue margin calls,

Â which are requests for more collateral to support open positions.

Â Instead they establish ratios of margin balances to open positions

Â that must be maintained at all times.

Â So let's take an example to help us understand how required

Â margin ratios work.

Â Say you have an account with some broker with a leverage ratio of 100 is to 1.

Â So, $1 of margin in your account can control $100 position size.

Â When your broker requires 100% margin ratio, meaning,

Â you need to maintain 100% of the required margins at all times.

Â The ratio varies from account size, but

Â 100% margin requirement is typical for small accounts.

Â That means to have a position size of $10,000,

Â you would need $100 in your account because $10,000 divided

Â by the leverage ratio of 100, is actually $100.

Â If your account's margin balance falls below the required ratio, your broker

Â probably has the right to close out your position without any notice to you.

Â If your broker liquidates your position, that usually means your losses are locked

Â in, and your margin balance just got smaller.

Â It's therefore very important for investors,

Â retail investors especially like you and

Â me to understand the broker's margin requirements and liquidation policies.

Â 3:11

Requirements may differ depending on account size and

Â whether you're trading say a standard lot size, which is 100,000 currency units,

Â or mini lot sizes, which are 10,000 currency units.

Â Some brokers' liquidation policies allow for

Â all positions to be liquidated if you fall below the margin requires.

Â Others close out the biggest losing positions, or

Â portions of losing positions until the required ratio is satisfied again.

Â You can find the details in the fine print of the opening

Â account contract that you signed.

Â And most brokerages these days put it in really fine print, really small font.

Â But it's important to always read the fine print to be sure you understand

Â your broker's margin and trading policies.

Â Also to understand what is called unrealized and realized profit and loss,

Â so let's understand what is unrealized and realized profit and loss.

Â Most forex brokers provide real time market-to-market calculation showing

Â your margin balance.

Â Market-to-market is the calculation that shows your unrealized P&L

Â based on where you could close your open position in the market at that instant.

Â Depending on your broker's trading platform, if you're long,

Â the calculation will typically be based on where you could sell at that moment.

Â If you're short, the price used will be where you can buy at that moment.

Â Your margin balance is the sum of your initial margin deposit,

Â your unrealized P&L, and your realized P&L.

Â Realized P&L is what you get when you close out a trade position or

Â a portion of a trade position.

Â If you close out the full position and go flat, whatever you made or

Â lost leaves the unrealized P&L calculation and then goes into your margin balance.

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If you only close a portion of your open positions,

Â only that part of the trade's P&L is realized and goes into the margin balance.

Â Your unrealized P&L continues to fluctuate based on the remaining

Â open positions, as does your total margin balance.

Â If you've got a winning position open, your unrealized P&L is positive, and

Â your margin balance increases.

Â If the market is moving against your positions,

Â your unrealized P&L is negative, and your margin balance is getting reduced.

Â Forex prices change constantly.

Â So your market to market unrealized P&L and

Â total margin balance also changes constantly.

Â 6:22

Now let's just look at a few currency pairs to help us get an idea of

Â what a PIP is.

Â Most currency pairs are quoted using five digits.

Â The placement of the decimal point depends on whether it's a yen currency pair,

Â in which case there are two digits behind the decimal point.

Â All of the currency pairs have four digits behind the decimal point.

Â In all cases, that last itty bitty digit is the PIP.

Â So let's take some major currency pairs and crosses and see what the PIP is.

Â Say for instance that Euro dollar is at 1.2853,

Â the last decimal point, 3, is called as the PIP.

Â Let's say Swizzie USD CHF is at 1.2867.

Â That 7 number is basically the PIP.

Â If, let's say USDJPY is at 117.23,

Â that 3 is basically the PIP in that yen FX rate.

Â If it's a euro yen and it's at 150.65 the 5 is the PIP on the euro yen.

Â So let's focus on the euro-USD price first.

Â Looking at the euro-USD the price moves from say 1.2853

Â to 1.2873, it's just gone up 20 PIPs.

Â If it goes from 1.2853 down to say 1.2792, it's just gone down by 61 PIPs.

Â PIPs provide an easy way to calculate the P&L.

Â To turn that PIP movement into a P&L calculation,

Â all you need to do is to basically take the size of the position.

Â Say, for instance, you have 100,000 euro dollar position.

Â The 20 PIP move equates to $200 because it's euros 100,000

Â times 20 PIPs, which is 0.0020, and that's $200.

Â For a 50,000 euro dollar position,

Â the 61 point move translates into $305 because that's

Â 50,000 euros times 0.0061, that's equal to 305.

Â Whether the amounts are positive or negative,

Â that depends on whether you were long or short for each move.

Â If you were short for the move,

Â for the move higher, that's a minus in front of the $200.

Â If you were long, it's a plus.

Â So, let's say you want to calculate that for another currency.

Â I mean, euro USD, which is what we considered earlier,

Â that's easy to calculate, especially for US dollar based traders,

Â because the P&L accrues in dollars.

Â Let's say you're trading dollar CHF, Swizzie.

Â Okay, and

Â you've got basically another calculation to make before you can make sense of that.

Â So that's because the P&L is going to be denominated in Swiss francs

Â because CHF is the Swiss francs is the counter currency.

Â If USD-CHF drops from 1.2267 to 1.2233,

Â and you're short US dollars 100,000 for

Â the move lower, you've just got caught 34 PIP decline.

Â That's a profit worth CHF $340, because that's a $100,000 times 34 PIPs,

Â which is 0.0034, that's equal to Swiss francs 340.

Â Yeah, so it's Swiss francs 340, but how much is that in US dollars?

Â To convert that into US dollars you need to divide

Â 9:57

the CHF 340 by the US dollar, Swiss franc rate.

Â You typically use, you'd always use the closing rate of the trade which

Â is 1.2233 because that's where the market was last.

Â And you would get about US $277.94.

Â Now things have changed, and they'll continue to change in the Forex market.

Â Even the venerable PIP has now got updated as electronic

Â trading continues to advance.

Â Half the prices have been the norm in certain currency pairs in

Â the the bank market for many years.

Â Now, with online markets and catching up,

Â we basically rapidly advancing to decimalizing PIPs,

Â which is basically one-tenth of a PIP, we are now trading in one-tenths of PIPs.

Â Now how do you factor in the profit and loss into the margin calculations?

Â The good news is that most FX trading platforms calculate the P&L for

Â you automatically.

Â Both unrealized, while the trade is open and realized when the trade is closed.

Â So I mean, then why do you need to essentially calculate the, or

Â do the calculations for P&L using PIPS?

Â Because brokerages only start calculating your P&L after you enter a trade.

Â To structure your trade what you need to do is to manage your risks effectively,

Â which is to understand how big a position do you want,

Â how much margin to risk, and so on.

Â And you're going to need to calculate your P&L, the outcomes,

Â before you actually enter the trade.

Â