A margin call is a notification given to Forex traders when their positions fall into negative territory and they need to deposit more funds into their trading accounts or close the losing trades to free up margin. This typically occurs when the margin falls below a broker-specified level of 60%, meaning the funds in the account no longer cover the margin requirements.
As soon as the margin level drops below 30%, the broker will initiate a stop out. Upon receiving the stop out, the broker will close the positions automatically until the previous level is reached.
What Is a Forex Stop Out Level?
In Forex trading, a stop out is an action automatically carried out by the Forex brokers when all of a trader’s active positions are moving against the traders. A stop out occurs when a trader’s margin level falls to a specific percentage- known as the stop out level — meaning they will not be able to support their open positions.
The following are the top reasons for Forex margin calls:
- Margin calls occur most frequently when traders commit a substantial portion of the equity to margin, leaving very little room for losses to be absorbed. From the broker’s perspective, this is a necessary technique for managing and reducing their risk accordingly.
- A Forex trader can also receive a margin call if they fail to monitor the margin level on a regular basis and fail to adequately fund their accounts.
- Making a trade without setting a stop-loss order during an aggressive price change can affect your margin as well, potentially resulting in a margin call.
- Excessive leverage may also adversely affect the trader’s margin, as they tempt traders to open more positions than they should, thereby triggering margin calls.
Understanding Forex Margin and Leverage
To understand a forex margin call better, one must understand the interrelated concepts of margin and leverage. Margin and leverage form a complementary pair of concepts. Leverage allows traders greater exposure to the markets without having to invest the entire amount for a trade, while margin is the minimum amount required to open a position.
The relationship between leverage and margin is inverse. However, Leverage and Margin describe the same concept, they are slightly different from their standpoint. The higher the leverage level, the smaller the required margin amount is.
For example, 2% of a $100,000 position size would be $2,000. To open this specific position, $2,000 is the Required Margin. As you can open a $100,000 position with just $2,000, your leverage ratio is 1:50.
The following two formulas summarize the relationship between leverage ratio and margin:
Leverage ratio = 100/Margin%
For example, if the Margin offered by the broker is 2%, then the leverage ratio is 1:50 (100 ÷ 2 = 50).
Where Margin = 1/Leverage ratio
A leverage ratio of 1:50 yields a margin percentage of 2% (1 ÷ 50 = 0.02).
You must keep in mind that trading with leverage involves risk and can lead to both large profits and large losses. Since your positions are magnified when you trade on leverage, you will need sufficient funds to protect you from market fluctuations.
What happens when a Margin Call takes place?
Margin calls occur when your equity percentage drops below a certain level. Margin calls are a warning that you are nearing the stop-out level, which could result in traders being liquidated or closed out of their trades. It serves two purposes: the trader no longer has the money to hold losing positions, and the broker takes responsibility for the trader’s losses, which is equally bad for them.
In certain circumstances, leveraged trading may result in a trader owing more to the broker than what was deposited, which is important to know. Keep in mind that the value of the instruments in your account changes every day as the market fluctuates, and clients with less equity should keep an eye on their accounts to avoid a margin call.
How to avoid a Margin Call?
Margin calls are something most forex traders prefer to avoid. Margin calls occur when you have incurred so many losses in your trade that the broker wants more money as collateral in order to continue the trade. The key to avoiding margin calls is to manage your trades well.
Understanding how to choose the right leverage level is crucial to avoiding margin calls in Forex trading. As leverage is often and appropriately referred to as a double-edged sword, the greater the leverage a trader uses — relative to the deposit — the smaller the available margin to absorb losses. An over-leveraged trade can quickly drain a trader’s account if the trade goes against them.
Best tips to prevent Forex Margin Calls:
Margin calls are common among amateur traders who hold their positions for a long time. They fail to dispose of a losing holding when it goes down. In order to maintain their losing position, they keep adding more funds to their account. Experienced traders, on the other hand, know when to cut their losses and liquidate their losing positions.
The following are the best tips to prevent you from getting into a margin call situation.
- Avoid over-leveraging your trading account. Keep it at a low leverage level.
- Make sure you are managing your risk carefully. You can avoid getting margin calls by using the best risk management strategies and using stop-loss orders.
- Maintain a healthy amount of free margin in your trading account to safeguard your ability to trade for the long term.
- Always try to trade in smaller sizes to prevent you from getting margin calls.
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