Lesson 3: Margin Call Explained

The sobering margin calls happen more often than you can imagine. An alarmingly large number of beginner traders experience this because their excitement gets the best of them. 

Assume you're new to trading and that your broker allows 100:1 leverage. You'll surely grab the opportunity and open huge positions with only a small amount of capital.  

However, leveraging your trade this way is simply deadly. If you do this, your account will suffer if the market moves against you. You can expect a margin call from your broker.

Lesson Highlights

• A margin call happens when your margin account has reached the maintenance requirement threshold.
• To avoid getting a margin call from a broker, a trader must set aside enough free margin in their margin account to support open positions.
• In case of a margin call, a broker will ask the trader to deposit funds to raise their margin account to the required level.
• Stop-out is a broker's last course of action to prevent the trader from losing further. During a stop-out, the broker liquidates the trader's open positions one by one until either nothing is left or when the equity rises back to the maintenance requirement.

What Is Margin and Margin Call?

When trading on margin, your broker expects you to lock in a deposit (required margin) for the leveraged position.  

When you open several margin positions, these deposits or required margins are accumulated into used margin. So, the used margin is the collection of your deposit or required margin.

Now, let's look at your equity. Your equity is the current balance of your trading account. It moves together with your open positions as they experience gains or losses.  

Let's review: 

1. Your equity shows how much money you have in your account. 
2. Your used margin is the amount you can't use unless you close its respective positions. 

Logically, when your equity reaches your used margin, your account doesn't have the means to support your existing positions.  

If that happens, you can expect a margin call from your broker. 

Margin Call Example Scenario 

Margin calls can be confusing, especially if you're new to margin trading. Let's look at the trading situation of Anne and see how her trading practices led to her getting a margin call.

Being new to trading, Anne promised herself not to put more than USD 5,000 into her capital. However, she realized that it was impossible to gain high returns with that amount of investment. 

But the great thing is that her broker offers margin trading; she can access huge positions with only a small deposit.

She wanted to open a long EUR/USD at 1.20000 with a standard lot. Her broker offers 50:1 leverage (2% margin requirement) for the EUR/USD pair. She would only need to set aside USD 2,4000 from her account balance (USD 5,000). 

Without leveraging her position, she would be required to put the whole USD 120,000 just to open and control one position. 

After executing the trade and gaining a floating profit of USD 100, her account looks like this: 

With the 10-pip rise of the EUR/USD value, Anne's position gains a profit of USD 100. Since she's new to trading, her excitement for potential high returns made her open a new position. 

For another time, she opened three long EUR/USD at 1.3000 with only a mini lot. One mini lot position costs her USD 260, but since she opened three positions, her additional used margin is USD 780.  

This transforms her used margin from USD 2,600 to USD 3,380.  

Considering that the EUR/USD has not moved yet since the 10-pip movement, her trading account looks like this now: 

Her margin level is at 150%, which is still healthy. This level is sufficient to support open positions, but she can't enter any more positions unless she deposits more money into her account.

However, her anticipated continuous upward trend of the EUR/USD did not happen. The market reversed and crashed against her position, causing her four EUR/USD positions to suffer. 

The market had a 90-pip movement, which accounts for a USD 1,070 floating loss to her equity. Now, her account margin level is nearing 100%, a deadly level.

Despite Anne's risky position, she keeps all her positions open. She knows she'll make huge money if the EUR/USD rises.  

However, the market kept declining. After a few minutes, Anne received a margin call from her broker.  

At this point, Anne can only do three things: 

1. Deposit more money to her account balance to increase her margin level. 
2. Close other positions to balance out her margin level. 
3. Hope that the market reverses before her margin reaches the stop-out level.  

What Is a Stop-Out

When your margin account reaches its stop-out level, your broker will start liquidating your open positions one by one. When they close one of your positions, the required margin used for it will accumulate in your equity, increasing your margin level.  

Stop-out is your broker's way of getting your level back above the stop-out level. Remember, different brokers have different stop-out levels. Read your broker's terms of use for margin trading and familiarize yourself with their minimum required levels.  

In the next article, you'll master the functionalities of leverage and margin and their best practices to avoid getting a margin call.  

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