In our previous article, by using a real-work example, we explained why it is important to take all trading expenses into consideration. Now it’s time to discuss what can be done if you don’t have enough money in your trading account balance.
Stop out and margin calls are the two expressions that terrify traders. Nobody obviously wishes to suffer losses when it comes to trading. This is why today we are going to talk about the essence of these concepts and how to avoid the margin call.
1. What Is the Difference Between Margin Call and Stop Out
2. When Does Margin Call Happen
3. How to Calculate Margin Call
4. How to Avoid Margin Call
5. Let’s Sum It Up
What Is the Difference Between Margin Call and Stop Out
Let’s start with the margin call. The majority of forex traders take advantage of leverages in their trading. This is what margin trading is. Essentially, it implies that you use an amount of money that is much bigger than the trading account balance. Margin is essentially money borrowed from the brokerage company.
In layman’s terms, the margin call is the notification given by the brokerage company saying that the equity in your account is insufficient to hold losing positions open and you need to deposit some money in your trading account, or else positions will be automatically closed. Previously in the stock market, people used to be informed about this by a phone call, thus the name “margin call.”
If you fail to replenish the account after receiving the said message, you will get stopped out i.e. all open trades will be forcibly closed.
When Does Margin Call Happen
What makes margin trading so appealing is that you can open positions much larger than the balance of your trading account. This means that the potential profit can be much higher as well.
However, there are also hidden pitfalls when it comes to margin trading. If the price moves against the open position, the loss will increase in proportion to the leverage. This is when you risk getting the margin call.
Here’s what you need to know about the stop out and margin call:
- Every brokerage company has a certain margin call threshold and forcible closure of positions. You need to be aware of it beforehand.
- Typically, the stop out occurs at the 50% margin level, and the margin call happens at 100%.
- Some brokers have the same margin call and stop out level, and close positions without sending you a warning message.
How to Calculate Margin Call
Suppose, you have read the terms and conditions of your brokerage company from cover to cover and found out that you get the margin at 100% margin level. Now what does this mean and how can you apply it in practical terms?
We can find out the value of the margin level by dividing the amount of account balance by the collateral for the traded instrument and multiplying the resulting figure by 100%.
Let’s calculate the margin call (Calculation example):
- Trading account balance — $1000;
- EUR/USD lirice — $1,1723;
- Lot size — 0.1;
- Leverage — 1:100;
- Margin amount — $117.23.
When opening the trade, the margin level will be: $1000/$117.23*100% = 853%
You will get the margin call at the 100% margin level. This will happen when the loss per trade will reach $882.77 ($1000 − $117.23*1.00 = $882.77).
That being said, there’s no need to make these calculations yourself every time, especially when you have several simultaneously open trades. You can check it out in the “Terminal” table of the MetaTrader 4 and MT5 trading platforms.
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How to Avoid Margin Call
If you trade with leverage, it means that you risk getting the margin call and even the stop out. How do you prevent this from happening? The only way is to observe money management rules.
Nobody can guarantee that the price won’t suddenly move against the open trade even when the forecast is accurate. So, be sure to learn how to manage forex risks.
Money and risk management is another essential element you need to master after learning the trading strategies and techniques. It’s important to be able to calculate the size of the stop-loss order and trade entry volume.
Here’s a short algorithm you can use to protect yourself against margin calls. If you are new to financial markets and have a lot to learn, make sure to use these handy tips:
1. Place stop loss in your trades at all times.
2. The level of the stop-loss order should meet the market requirements and your trading strategy (e.g. “I place it behind the local high/low” or “it must always be 20 pips”).
3. Determine a maximum risk per trade. Ideally, it must not exceed 2% of the account balance. You can make a more accurate calculation if you know the expected value of the trading strategy.
4. Based on the risk percentage per trade and the size of the stop-loss order in pips, calculate the lot you will enter the trade with. It may not be the same for each position.
5. Make sure that the margin level in the trading terminal is higher than the margin call level. If according to the broker’s requirement, the margin call occurs at the 100% margin level, your margin should be over 300%. This way you will be able to minimize your risks, preserve your trading account, and spare your nerves.
Let’s Sum It Up
In the trading world, the margin call is an indirect sign that the trader is managing money incorrectly.
They say it’s better to prevent a problem than solving it later. Having a safe and reliable money management strategy is what can protect you against the margin call. Make sure to learn how to work it out and then follow its rules religiously.
Also make sure to watch this short video.