MARGIN CALLS IN FOREX TRADING – MAIN TALKING POINTS:
- A brief overview of margin and leverage
- Margin call causes
- Procedure for margin calls
- How to prevent margin calls
In forex, traders would do everything to avoid a margin call. Therefore, for effective trading, it is crucial to comprehend how margin calls occur. The margin call and ways to prevent it are thoroughly examined in this essay.
Never comply with a margin call. You’re in a market on the incorrect side. Why waste good money on lousy people? Save the cash for a future day. Jessie Livermore
Leverage and Margin
Understanding how margin and leverage connect to one another is crucial for comprehending a forex margin call. Leverage and margin work together as one. Leverage gives traders more exposure to markets without requiring them to finance the whole deal, and margin is the minimal amount of money needed to conduct a leveraged trade.
It’s vital to keep in mind that trading with leverage carries risk and may result in both significant gains as well as sizable losses. For advice on how to reduce risk while trading, see our introduction to risk management.
WHAT CAUSES A FOREX TRADING MARGIN CALL?
A margin call occurs when a trader runs out of useable or free margin. In other words, more money is required for the account. This often occurs when trading losses bring the useable margin below a threshold the broker has set as acceptable.
When traders allocate a substantial part of equity to utilized margin, leaving little space for loss absorption, a margin call is more likely to happen. This is a crucial method from the broker’s perspective in order to successfully manage and lower their risk.
The following are the most common reasons for margin calls, listed in no particular order:
- Holding on to a bad deal for too long, reducing useful margin
- Using your account excessively in addition to the first justification
- An underfunded account that forces you to overtrade with insufficient useable margin
- When the price swings strongly in the other direction, trade without stops.
WHAT HAPPENS DURING A MARGIN CALL?
A trader’s positions are liquidated or closed out when a margin call occurs. The trader no longer has the funds in their account to maintain the losing positions, and the broker is now liable for those losses, which is also terrible for the broker. It’s crucial to be aware that using leverage in trading might, in certain cases, result in a trader owing the broker money that exceeds what has been deposited.
A trading account with a high likelihood of obtaining a margin call is shown below:
$10 000 as a deposit
Number of normal (100k traded lots): four
2% is the margin percentage.
Margin used: $9,000
Free margin: $1,000
*With the EUR/USD at 1.125, the used margin is computed as follows:
Size of trade x price x margin % x number of lots
$100 000 × 1125 x 2% x 4 lots = $9 000
For the sake of simplicity, this is the sole open position, and it represents all of the utilized margin. It is obvious that most of the account equity is consumed by the margin needed to maintain the open position. There is just a $1,000 free margin after this.
The use of leverage implies that the account is less able to withstand significant moves against the trader, despite the fact that traders may operate under the erroneous premise that the account is healthy. In this example, if the market moves by more than 25 points ($40 per point x 25 points = $1000), the trader will be subject to a margin call and have their position liquidated.
How can margin call be avoided?
It’s common and appropriate to describe leverage as a two-edged sword. The idea behind such remark is that a trader will have less useful margin to absorb losses the more leverage they utilise in relation to the amount they deposited. If a trader loses money on an excessively leveraged deal, their losses might swiftly wipe out their account, which makes the situation much worse.
A trader will get a margin call when the useable margin percentage falls to zero. This simply serves to strengthen the case for utilizing protective stops to minimize potential losses.
Consider the scenario below, where the only difference between two deals is the amount of leverage, to better illustrate the impact of leverage on a trader’s account:
In the end, because we cannot predict the price movement of tomorrow, we must exercise caution while choosing the suitable leverage for trading.
Top 4 strategies for avoiding margin calls while trading forex:
- Leverage your trading account prudently. Reduce your leverage’s effectiveness.
- Use stops to minimize your losses and exercise cautious risk management.
- To remain in trades, have a sufficient amount of free margin on the account.
- Transaction in smaller lots and think of each trade as merely one of a thousand little, meaningless deals.