The margin call is a warning sign, which the broker sends to the trader to deposit new funds into the account when losses on open trades are close to a critical level. If the trader does not make a new deposit in his account and the losses continue to increase, the broker can proceed to a forced closing of transactions ( Stop Out ).
The stop out occurs when the margin level is insufficient to keep the positions open. Brokers indicate in their agreements the percentage of this level, which may be different in each case.
Margin level control is one of the essential rules of risk management. In order to make this process very optimal, professional traders often create models, which allow to estimate the level of the required minimum margin with a specified leverage and trading volume.
The deposit is the amount of funds deposited in the trading account.
The balance is the amount of the trader's funds at the moment. It is equal to the current balance adjusted for unrealized profits or losses.
Margin (also called "collateral") is the amount of money required to open a position. If the trader buys the Euro for a value of $10,000 and with a leverage of 1:100, the required margin will be $100.
Free margin is the capital not involved in the trade that the trader can use at his discretion.
The margin level serves as an indicator that reflects the account balance and is expressed as a percentage. If its value falls below the stop out set by the broker, the closing of positions begins.
What is Margin Trading?
Margin trading allows trading in the markets with leverage . Margin makes it possible to open positions for a total amount of ten, one hundred, or even one thousand times greater than that of the trader's entire deposit, provided that this amount is returned.
Each broker has its own leverage, but the maximum allowed in Europe for retail traders is 1:30. Some offshore brokers offer 1:1000 leverage which allows traders to open trades with a volume a thousand times larger than their deposits.
Without leverage - The trader has 1000 dollars, including 600 dollars to invest in oil. Oil volatility is low: -0.1-0.3% per day. Suppose the trader trades intraday and in the oil market a force majeure event occurs and as a result the price of oil instantly drops by 5% i.e. from 60 to 57 dollars per barrel. If the trader opened a long position with his $600, the losses will be 600*0.05=$30.
With leverage - Suppose the trader is convinced that the price of oil will rise and he decides to apply the leverage of 1:100. The broker keeps $600 of the deposit as collateral and $400 for the free margin (uncommitted balance) which will act as insurance. Thus, the trader opens a position with a value of 600*100 = $60,000. Force majeure ruins the investor's plans and the loss of $30 becomes $3,000. Since the trader does not have this money in his account, all his trades will be forcibly closed before the price of oil drops to the $57 level. It is easy to calculate that the collateral of $600 with the indicated leverage is able to withstand a price drop of only 1% ($0.60), the uncommitted balance ($400) - 0.40 $ more.
Margin Call is a situation in which the broker informs the trader of the need to deposit new funds in the account in case of reduction of the sum below the established level. This is a kind of warning that the trader's deposit under current conditions will soon end.
Stop Out is a forced closing of open trades when the minimum level of margin required to maintain open positions is reached. For example, you have an account of $2000, of which $1000 is margin used on open positions, the Stop Out is set at 30%. Your account balance must therefore always be greater than 1000 / 30 = $300 to avoid the Stop Out.
Unlike other types of loans, the trader does not regularly pay a percentage for using the loan. Forex brokers have a currency swap , a commission that is charged for keeping a position open at the end of the day. The swap is charged against all open positions, including those in which the loan funds are involved, and deducted from the trader's own funds, thus accelerating the reduction of the balance.
How to avoid margin call and stop-out?
Read your broker's trading conditions and margin call and stop out levels depending on account type.
Adhere to comprehensive risk management standards. The theory is that the sum of positions opened simultaneously should not exceed 10% (rarely 15%) of the deposit amount.
Exercise caution when using leverage. Set a maximum volume of positions and do not try to open the maximum possible position.
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Estimate the share of leverage and volatility. The higher the volatility, the lower the leverage should be.