Forex stop out level - what does it mean?
When people use margin to leverage larger trading positions, it can have various effects. Namely, it can:
- Increase payouts received from larger positions
- Reach the “maintenance margin” level where opening new positions is not possible
- Go below the maintenance margin - a margin call level
- Go below the margin call level - FX stop out level
Since we have already covered the part where margin and leverage increase the position size and payouts, We won’t mention that in this article. Instead, let’s see what happens when the margin level goes below 100% because that is where the stop out level occurs.
When margin level goes below 100%
Traders try to maintain the margin level above 100%. That way, there is a possibility to open new positions, as well as maintain the existing ones. But if the open positions are not successful and lead to losses, the account balance - and the available equity with it - will start to decline. This will make the margin level reduce as well.
Usually, when the level reaches 100%, the Forex broker will initiate a margin call: notify a trader that he/she needs to refill their account or close (liquidate) some positions until the margin level goes above 100% again. However, if they fail to do that, a broker will be able to close the positions itself.
This point where a broker can decide whether to close positions or not is called the margin call level. Even though they can do that, brokers may choose not to liquidate positions and wait for the clients to refill their account balance.
What is the stop out level Forex traders want to avoid?
If the trading positions continue to bring more losses, a new stage will begin. Now, it varies from one broker to another but generally, this point is set to a 50% margin level. If the level goes below that, the “stop out” level will start.
A stop out is a process of liquidating (closing) open positions automatically. This happens because, again, the available equity on the balance isn’t enough to maintain even the existing positions, not to mention to open the new ones.
Usually, when the stop out level occurs, the brokers try to liquidate the most ineffective positions first (the ones that are damaging your account balance most). They tend to keep liquidating trades until the stop out level stops and the margin call level occurs. They do this because if the losses continue to increase, they will finally lead a trader to a “negative account balance” - when there are more losses to the account balance than funds. It’s something like an unpaid loan and no trader wants to experience it.
50% stop out level example
Let’s take a look at the example with a GBP/EUR position and see how all this works in real life. Let’s say a trader has 1,000 sterling as the available equity, the margin requirement for a 10,000-sterling position was 2%. Therefore, the used margin was 200 pounds.
Now, to calculate the margin level, we have to divide the available equity to the used margin and put it in a percentage: (1,000/200)x100%=500%. In this case, a trader has a 500% margin level on their account and can freely open new trades. However, as the number of trades increases, so does the used margin, which reduces the margin level.
Let’s assume that the trade didn’t go as planned and the GBP/EUR price went down. At first, the loss was insignificant, but after some time, it became large enough to threaten the whole balance. Shortly afterward, the losses reached 800 pounds in this trade.
As a result, the margin level came down to 100% because the available equity reduced to 200 pounds from the previous 1,000 pounds. At this point, a Forex broker sends a warning - a margin call - to a trader to refill the balance or liquidate the position.
How to calculate stop out level in Forex?
Let’s say a trader didn’t do much to change the situation and the losses continued to increase (the broker chose not to close the position for now). After some time, the loss reached 900 pounds and the margin level came down to 50%. At this point, the broker automatically liquidates the position (begins the stop out level Forex) in order to stop the losses and avoid a negative account balance on its client’s account.
When the account is liquidated, i.e. sold to the Forex market, the used margin will become zero (in other cases, where there are several trades open, it will simply reduce). This way, a trader will still have 100 pounds left on their account balance.
What is a stop out level in Forex and how does it differ from margin call level?
A stop out level may have different names like Margin Closeout Value, Liquidation Margin, or Minimum Required Margin, but all of them are the same: they mark the point where a broker starts liquidating existing positions.
Now, the two levels below 100% - a margin call level and a stop out level - may seem similar in some ways, but there is the main difference between them as well. They are similar because Forex brokers start to close positions at that point.
However, at the margin call level, a broker has an option not to do that and wait for a trader to refill their account balance or liquidate some positions. On the other hand, the liquidation process is automatic on the stop out level, meaning the broker has no option. That is the main difference between them, and there’s also the fact that the stop out level is closer to a negative account balance - probably the most dangerous thing for a Forex trader.