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Margin Call
In the context of forex trading, a Margin Call refers to a situation where the trader’s account equity has fallen below a certain percentage (usually 100%) of the required margin for their open positions.
What is a Margin Call?
A Margin Call is a warning from the broker that the trader’s account is in danger of experiencing a complete loss of their positions. It is the broker’s way of notifying the trader that their account has reached a critical level of equity compared to the margin required for their open trades.
Margin Call Level
The Margin Call Level is the specific threshold or percentage value that triggers the Margin Call event. For example, if a broker has set the Margin Call Level at 100%, it means that when the trader’s Margin Level (calculated as Equity / Used Margin x 100%) falls to 100% or below, the broker will issue a Margin Call.
Purpose of a Margin Call
The primary purpose of a Margin Call is to give the trader an opportunity to add more funds to their account or close some of their open positions. This would help bring the Margin Level back above the required threshold and prevent the broker from having to forcefully close the trader’s positions.
Trader’s Actions After a Margin Call
When a Margin Call is issued, the trader has the following options:
1.Deposit Additional Funds: The trader can deposit more funds into their account to increase the Equity and bring the Margin Level back above the required threshold.
2.Close Open Positions: The trader can choose to close some or all of their open positions, which would reduce the Used Margin and thereby increase the Margin Level.
Outcome of a Margin Call
If the trader is able to successfully respond to the Margin Call by either depositing funds or closing positions, their account will remain active, and they can continue trading. However, if the trader fails to take appropriate action, the broker may proceed to the next level, which is the Stop-Out Level.
Remember, a Margin Call is a warning, and it’s in the trader’s best interest to take immediate action to avoid further losses and the potential for a forced liquidation of their positions.
Stop Out Level
The Stop Out Level is another critical threshold set by your forex broker. It is the final line of defense when your trading account is at risk of experiencing significant losses.
What is a Stop Out Level?
The Stop Out Level is a specific Margin Level percentage set by your broker, at which point your broker will automatically start closing your open positions. This is done to protect your account from further losses and to ensure that your account does not go into a negative balance.
How Does the Stop Out Level Work?
When your Margin Level falls below the Stop Out Level, your broker will begin to close your open positions, starting with the position that has the largest unrealized loss. This process will continue until your Margin Level is brought back above the Stop Out Level.
The Stop Out Level is typically set at a lower percentage than the Margin Call Level. For example, a broker might have a Margin Call Level of 100% and a Stop Out Level of 50%.
Importance of the Stop Out Level
The Stop Out Level is a critical risk management tool in forex trading. It helps to ensure that your losses do not spiral out of control, and that your account does not go into a negative balance. This is especially important in volatile market conditions, where large price swings can quickly deplete your account balance.
By setting a Stop Out Level, your broker is effectively protecting you from yourself and your own trading decisions. Even if you fail to respond to a Margin Call, your broker will step in and close your positions to prevent further losses.
Avoiding the Stop Out Level
To avoid reaching the Stop Out Level, it’s important to keep a close eye on your Margin Level and to take action as soon as you receive a Margin Call. This may involve depositing additional funds into your account, closing out open positions, or adjusting your trading strategy to reduce your overall risk exposure.
By staying proactive and managing your risk effectively, you can avoid the stress and consequences of a Stop Out event, and maintain the integrity of your trading account.
Example 1: Forex Margin Call and Stop-Out
Let’s consider a trader named Sarah who has a $5,000 trading account and decides to open a long position on the EUR/USD currency pair with a leverage of 1:100.
Margin Call Scenario
•Sarah opens a long position on the EUR/USD with a lot size of 0.5 lots (50,000 units)
•The required margin for this position is $500 (0.5 lots x $1,000 per lot)
•The Margin Call Level is set at 100% by Sarah’s broker
•The market starts moving against Sarah’s position, and the EUR/USD pair drops by 200 pips
•This results in a floating loss of $1,000 (200 pips x $5 per pip)
•Sarah’s Equity is now $4,000 ($5,000 – $1,000)
•Her Margin Level is now 80% ($4,000 / $500 x 100%)
•Since the Margin Level is above the 100% Margin Call Level, Sarah receives a Margin Call from her broker
Stop-Out Scenario
•If Sarah does not add more funds to her account or close the position, the market continues to move against her
•The EUR/USD pair drops by an additional 300 pips, resulting in a total floating loss of $2,500 (500 pips x $5 per pip)
•Sarah’s Equity is now $2,500 ($5,000 – $2,500)
•Her Margin Level is now 50% ($2,500 / $500 x 100%)
•Since the Margin Level has fallen below the broker’s Stop-Out Level (e.g., 50%), the broker automatically closes Sarah’s position to prevent further losses
Example 2: Gold Margin Call and Stop-Out
In this example, let’s consider a trader named John who has a $10,000 trading account and decides to open a short position on gold (XAU/USD) with a leverage of 1:50.
Margin Call Scenario
•John opens a short position on XAU/USD with a lot size of 0.5 lots (50 ounces)
•The required margin for this position is $1,000 (0.5 lots x $2,000 per lot)
•The Margin Call Level is set at 100% by John’s broker
•The gold price starts to rise, and the XAU/USD pair increases by $100 per ounce
•This results in a floating loss of $2,500 (100 oz x $100 per oz)
•John’s Equity is now $7,500 ($10,000 – $2,500)
•His Margin Level is now 75% ($7,500 / $1,000 x 100%)
•Since the Margin Level is above the 100% Margin Call Level, John receives a Margin Call from his broker
Stop-Out Scenario
•If John does not add more funds to his account or close the position, the gold price continues to rise
•The XAU/USD pair increases by an additional $150 per ounce, resulting in a total floating loss of $5,000 (150 oz x $150 per oz)
•John’s Equity is now $5,000 ($10,000 – $5,000)
* His Margin Level is now 50% ($5,000 / $1,000 x 100%)
•Since the Margin Level has fallen below the broker’s Stop-Out Level (e.g., 50%), the broker automatically closes John’s position to prevent further losses
In both examples, the Margin Call Level and Stop-Out Level serve as important risk management tools to protect the trader’s account from significant losses. It’s crucial for traders to closely monitor their Margin Levels and take appropriate actions to avoid reaching these critical thresholds.
Difference between stop-out level and margin call
| Attribute | Margin Call | Stop-Out Level |
|---|---|---|
| Definition | A warning from the broker that the trader’s account equity has fallen below a certain percentage (usually 100%) of the required margin for their open positions. | The point at which the broker will automatically close the trader’s open positions to prevent further losses. |
| Trigger Level | Usually set at 100% of the required margin. | Usually set at a lower level than the margin call, often around 50% of the required margin. |
| Purpose | To give the trader a chance to add more funds or close positions to bring their margin level back above the required threshold. | To protect the trader’s account from going into negative equity. |
| Trader’s Action | The trader has the opportunity to deposit additional funds or close trades to bring their margin level back above the required threshold. | The trader’s positions are forcefully closed by the broker, and they no longer have the option to add more funds or manually close the trades. |
| Outcome | The trader’s positions remain open, and they have a chance to take action. | The trader’s positions are automatically closed by the broker. |