What happens before the margin call in Forex occurs?
As we have already discussed, trading Forex requires large deposits and position sizes in order to get significant results. Of course, trading is possible with smaller deposits as well but they’re usually not sufficient to bring sufficient payouts. Therefore, many traders use margin accounts to leverage higher trading positions.
Main elements of margin trading
When using the margin account, there are certain elements that a trader needs to know to have a better idea of what they are dealing with. So, before jumping to what does margin call mean and how does it work, here are some of the elements:
- Available equity: a sum of money left on the account balance that can be used to open new trades with leveraged positions. The more available equity a trader has, the better for his/her trading account;
- Used margin: a sum of money that the broker took from the trader’s account in order to open a leveraged position. The more used margin a trader accumulates, the less he/she can open new trades;
- Free margin: a sum of money left from the account balance after the broker took the used margin. It shows that there is still a certain amount left that can be used for starting additional trades;
- Margin level: a value received by dividing available equity to used margin, represented in a percentage. It indicates the ratio between the available and used funds and shows whether it’s possible to open new positions. The higher the margin level, the more trades can be started.
- Maintenance margin: a certain point of margin level necessary to at least maintain the existing trades. Various service providers have different values, but the most popular one is 100%. Therefore, if the available equity and used margin become equal, a trader cannot open new trades.
When do margin calls happen?
The elements we discussed above are necessary to keep track of the account balance and make sure that nothing unexpected happens. However, no trader can be certain that the currency prices don’t fall and their account balance doesn’t reduce.
When such things happen, the margin level starts to decline. It is even possible to go below 100%. In this case, the Forex broker will notify a trader that their margin level is below the maintenance margin, there are no funds on their account to maintain even the existing trades, and they need to deposit more funds to restore the balance.
As an alternative, traders can also close some of their trades (“liquidate”) until, again, at least the maintenance margin is restored. The notification received from a broker is called a margin call and it is usually in the form of an email or a text message.
Margin call example
What is a margin call? To understand this process more easily, let’s take a look at the example: Let’s imagine that you have $5,000 on your account balance and want to open a short position (sell) for USD/JPY position with 1 lot (100,000 currency units). For this example, the required margin will be 3%, therefore, the broker takes $3,000 from your balance.
In this case, the used margin will be $3,000 while $2,000 will remain as a free margin. In total, you will still have $5,000 available equity on your account because the trade hasn’t started and payouts/losses haven’t occurred yet.
So, you have opened a trade, sold a USD/JPY currency pair for one lot and are expecting the price to go down. However, it seems the fortune is not on your side and the price starts to go up. Let’s imagine that the price declined so much that it resulted in a $2,000 loss for you.
At this point, you have $3,000 left as the available equity, while the free margin is already zero. Do you remember what a margin level is? It is a ratio between available equity and used margin. In our example, the margin level will be 100% (3,000/3,000x100%). At this point, a broker will probably send you a margin call, asking you to either refill your account or liquidate the trade.
Margin call level vs margin calls explained
The point where your broker initiates a margin call is called the margin call level. While it is similar to the margin call, the two terms are not the same.
A margin call is a notification about reducing funds and the suggestion to refill the balance or liquidate trades. It’s essentially an event occurring at some point in Forex trading.
Whereas a margin call level is a certain point of the margin level which leads to the margin call. It’s basically an answer to this question: When is margin call occurring? For example, if a margin call level is 100%, and the margin level starts to go below this point, the broker will send a margin call to its client. Therefore, the two terms are interconnected but still are not the same.
Be careful about going below 100%, especially if it’s below a certain point
Now, to get back to our example, let’s imagine that the price on USD/JPY doesn’t stop there and continues to decline. And right after it crosses the 100% line and a trader fails to refill the account, the broker gets the ability to liquidate trader’s positions manually.
But even at this point of margin call level, a Forex broker can choose not to do that and wait for further developments. Maybe the price starts to recover and bring lost funds back. Therefore, at this point, not everything is lost and the liquidation of positions depends on a broker.
However, if the price still continues to decline and your margin level goes even lower the Forex margin call level, a trader gets to the new level - the “stop out” level. Various Forex brokers have different stop out level requirements, but usually, it varies around 50%. Therefore, when the margin level comes below 50%, your broker will start an activity called a “stop out”.
At this point, a broker will close/liquidate the most unprofitable positions that are damaging the overall account most. This process will last until the margin level is back at least above the stop out level.
But unlike the margin call level, where positions can also be liquidated, in a stop out level, this process is automatic and the broker cannot choose not to close trader’s positions.
Traders are usually very careful about their margin levels and do their best not to reach the margin call level, not to mention the stop out level.