Key Takeaways
- Equity is your real-time account value (balance + unrealized P/L); free margin is the portion of that equity available to open new trades.
- Monitor the margin level (%) using the margin level formula — it’s the single most important early warning for margin calls and stop-outs.
- Use conservative position sizing and margin rules, account for leverage and free margin relationship, and practice with a margin calculator or worked examples before you trade live.
- Clear examples and a short checklist (below) make these concepts operational — not just theoretical.
Understanding Equity in Trading
What equity represents in your account
Equity is the current value of your trading account: the account balance plus any unrealized profit or loss (P/L) from open positions. While account balance reflects settled cash (closed trades and deposits/withdrawals), equity changes constantly as markets move.
Put simply:
- Balance = settled cash after closed trades.
- Equity = balance + floating (unrealized) P/L.
Because equity is dynamic, it’s the number you should watch for real-time risk decisions.
How equity fluctuates with open positions
Every pip, point, or basis point in an open position changes your floating P/L and therefore your equity. That change affects your free margin and the margin level (%) — the core risk gauges for margin trading. Large open positions, high leverage, or volatile markets make equity swing more dramatically.
Equity vs account balance
Balance is stable until trades are closed. Equity is live. Example uses:
- Use balance for bookkeeping and long-term returns.
- Use equity for intra-day risk checks and margin calculations.
Example of equity calculation
Scenario (simple):
- Account balance: $10,000
- One open trade with unrealized profit: +$300
Equity = Balance + Unrealized P/L
Equity = $10,000 + $300 = $10,300
This equity number is the true, up-to-the-second account value that determines your ability to open or sustain positions.
Step-by-step scenario of equity in a live trade
- Deposit $10,000 (balance = $10,000).
- Open a position that shows +$300 unrealized P/L after favorable moves.
- Equity = 10,000 + 300 = 10,300.
- If the market reverses by $400, equity becomes 10,000 − 100 = $9,900 (and that change may influence margin calls).
Free Margin Explained
Definition and importance of free margin
Free margin (also called available margin) is the portion of equity that is not tied up in used margin. It’s the cash buffer you have to open new positions or to absorb losses on existing ones.
Formula (basic):
Free Margin = Equity − Used Margin
Keeping free margin positive and healthy is essential to avoid forced position closures and preserve trading flexibility.
Free margin vs used margin
- Used margin: the amount the broker holds to maintain your open positions (based on margin requirements).
- Free margin: equity left over after accounting for used margin.
Think: used margin is “locked” to keep current positions open; free margin is “spendable” for new trades or to absorb losses.
The role of free margin in managing risk
Free margin acts as an early warning system. If free margin shrinks toward zero, you have less room to tolerate adverse moves. Brokers monitor margin level (%) and will issue margin calls or begin stop-out procedures if equity falls relative to used margin.
Free margin calculation
Formula: Free Margin = Equity − Used Margin.
Worked example (full):
- Balance: $10,000
- Unrealized P/L: +$300 → Equity = $10,300 (as above)
- Used margin for current position(s): $2,000
Free Margin = $10,300 − $2,000 = $8,300
This $8,300 is what you can use to open new positions (subject to margin requirements) or to absorb further losses.
Available margin calculation example (leverage context):
If your broker uses 50:1 leverage, a $50,000 position requires $50,000 / 50 = $1,000 of used margin. That $1,000 reduces your free margin by the same amount.
The Relationship Between Equity and Free Margin
How equity impacts free margin
Because free margin is calculated from equity, any unrealized loss reduces free margin immediately; unrealized gains increase it. Traders who chase returns without watching equity risk sudden exposure to margin calls if the market turns.
Leverage and free margin relationship
Higher leverage reduces the margin required to open a position — which increases buying power but reduces the cushion against losses. The relationship is direct:
- Higher leverage → lower used margin for the same position → higher free margin initially, but much higher volatility in equity for a given market move.
- Lower leverage → higher used margin but more room for price moves before hitting stop-out levels.
Example: margin requirement calculation
- Position size: $50,000
- Leverage: 50:1 → margin required = $50,000 / 50 = $1,000
Even though the initial free margin impact is modest, a small adverse move can create a large unrealized P/L swing relative to that $1,000 margin.
Key Risk Ratios Every Trader Should Track
Margin level formula: how to assess your risk
The single most important ratio is the margin level:
Margin Level (%) = (Equity / Used Margin) × 100
This percentage tells you how much buffer you have relative to the broker’s required collateral. Brokers often set thresholds:
- Margin Call at some level (e.g., 100%): broker warns you to add funds or reduce positions.
- Stop-out at lower level (e.g., 50%): broker may start closing positions automatically.
Example (from earlier):
Equity = $10,300 ; Used margin = $2,000
Margin level (%) = (10,300 / 2,000) × 100 = 515%
A high margin level indicates a comfortable buffer; when it drops close to your broker’s stop-out threshold, prompt action is required.
Risk-to-reward ratios in relation to equity and free margin
Risk-to-reward (R:R) guides how much you stand to win versus lose per trade. But R:R must be married to position sizing, which draws on free margin.
Quick rule: risk a small fixed percentage of equity per trade (common: 0.5–2%). This ties position size directly to equity and therefore to your free margin reserves.
How free margin influences margin call and stop-out
As free margin declines toward zero, margin level declines in parallel. Once margin level hits the broker’s stop-out threshold, the broker may close positions — often the least favorable ones — which is why maintaining a buffer is critical.
Practical example: avoiding margin calls
Scenario:
- Start balance: $5,000
- Used margin: $2,000
- Broker stop-out level: 50%
Compute equity level that triggers stop-out:
- Equity required for stop-out = Used margin × (Stop-out % / 100)
- Equity required = $2,000 × 0.5 = $1,000
So if equity falls to $1,000, the broker may begin closing positions. To drop from $5,000 to $1,000 requires an unrealized loss of $4,000 — a large move, but not impossible with high leverage or major market moves. The practical lesson: keep free margin buffers and size positions so even a large but plausible move won’t reach stop-out.
Free Margin in Forex vs Other Markets
Differences in free margin requirements across asset classes
Margin rules vary:
- Forex: often offered with high leverage (e.g., up to 100:1), so used margin can be small relative to position size. That increases buying power — and risk.
- Equities: margin requirements are typically stricter (Reg T in the US often requires 50% initial margin for many trades), resulting in larger used margin and lower leverage.
- Derivatives/options/futures: margining depends on exchange rules and is often calculated with specific models (e.g., SPAN).
Managing free margin in high-leverage trading
When leverage is high:
- Reduce position size per trade.
- Use tight risk-per-trade limits (0.5–1%).
- Prefer protective orders or options to limit downside.
High leverage can inflate free margin early, lulling traders into larger positions that equity swings can quickly erase.
Strategies for Effective Free Margin Management
Avoid over-leveraging
Leverage magnifies both gains and losses. Practical rules:
- Treat leverage as a tool to increase flexibility, not to multiply bets.
- If new to leverage, limit exposure to ≤25% of allowed buying power.
Setting stop-loss orders strategically
Place stops beyond typical noise but inside your risk tolerance. Consider slippage and spread when setting stops, especially in fast markets.
Monitoring market volatility to protect equity
Use volatility measures (ATR, implied volatility) to size positions and widen stops appropriately. During scheduled announcements or illiquid sessions, reduce exposure or stand aside.
Common Trader Mistakes with Equity and Free Margin
Overestimating free margin
Traders often interpret free margin as “extra profit” and increase position sizes prematurely. Remember: it’s collateral, not disposable cash.
Ignoring margin level warnings
Ignoring margin alerts invites forced liquidation. Treat margin calls as a real risk — add funds or reduce exposure when alerts appear.
Failing to adjust positions during volatile markets
Markets change. A position size that was safe yesterday might be risky today. Regularly re-check equity, used margin, and margin level (%) as volatility shifts.
Final Thoughts on Equity vs Free Margin
Summary of key takeaways
- Equity is your live account value; free margin is what’s available to trade or absorb losses.
- The margin level formula is the most actionable ratio for margin traders. Monitor it constantly.
- Use disciplined position sizing and margin management to survive volatility and avoid margin calls or stop-outs.
Best practices for risk management
- Risk a small percentage of equity per trade (0.5–2%).
- Keep a buffer of free margin — don’t run flat.
- Use a margin calculator and test scenarios (slippage, worst-case moves) before committing real capital.
FAQ
Can free margin be withdrawn?
Generally, only the account balance (closed trade profits and deposits) can be withdrawn. Free margin is available to open new positions or to cover losses but may be restricted if used as collateral. Always check your broker’s withdrawal rules.
What happens when free margin reaches zero?
When free margin is zero, you cannot open new trades. If losses continue and margin level drops to the broker’s stop-out threshold, the broker may automatically close positions to prevent further negative equity.
How do leverage changes affect free margin?
Increasing leverage reduces the margin requirement for new positions (raising theoretical free margin), but it also increases the sensitivity of equity to market moves. Lower leverage reduces available buying power but increases the buffer before margin calls.
Quick reference table
| Term | What it means | Formula / Note |
| Balance | Settled cash after closed trades | — |
| Equity | Real-time account value | Equity = Balance + Unrealized P/L |
| Used margin | Collateral held for open positions | Broker-defined per position |
| Free margin | Margin available to open trades | Free Margin = Equity − Used Margin |
| Margin level (%) | Buffer metric vs used margin | Margin Level = (Equity / Used Margin) × 100 |