Risks and Margin Calls

Loosing money in forex is the part of the game. Don’t let it freak you out, however it doesn’t mean you can be careless. Loosing money and learning from mistakes is one thing. 

Careless trading is another story. If you aren’t careful, your account funds can fall below the available amount (which is called Margin Call). When this happens, your forex broker has every right to shut down some or even all open positions to stop your account from getting into negative balance. A good thing about it that you will never lose more money than you actually have. The bad thing is that Margin Call are evil and here is why.

Stay away from Margin Calls by monitoring your trading activities and margin balance. Set stop/loss orders on your positions and minimize the risk of loss. There are many tools to help you out with almost all trading platforms we have reviewed over the years.

WHAT CAUSES A MARGIN CALL IN FOREX TRADING?

A margin call is what happens when a trader no longer has any usable/free margin. In other words, the account needs more funding. This tends to happen when trading losses reduce the usable margin below an acceptable level determined by the broker.

Margin call is more likely to occur when traders commit a large portion of equity to used margin, leaving very little room to absorb losses. From the broker’s point of view this is a necessary mechanism to manage and reduce their risk effectively.

Below are the top causes for margin calls, presented in no specific order:

  • Holding on to a losing trade too long which depletes usable margin
  • Over-leveraging your account combined with the first reason
  • An underfunded account which will force you to over trade with too little usable margin
  • Trading without stops when price moves aggressively in the opposite direction.

Margin

is an insurance deposit which provides cover of possible losses of a marginal trade, and is used as a pledge.

Maintenance Margin

minimum amount on trader’s deposit necessary to maintain his open positions.

Margin Call

a message from a broker to a trader saying that it is necessary to increase funds on marginal account.

Margin Level

an indicator showing the state of a trader’s trading account.

If you do trade on margin account make sure to be very clear about the broker’s policies and all those conditions written in very tiny font. The last thing you need is to get into trouble. For example, during the weekend the margin can raise from 1% to 2 or even higher. 

The core concept of money management is to avoid risking more than 1-2% of personal funds on any single trade. This principle may greatly reduce risk exposure: provided that only 1% of initial deposit is at risk, even after several losing trades you are likely to retain the majority of account balance.

Risk to reward ratio denotes the potential profit in comparison to the amount you may lose for any given trade. For example, when you risk 100 USD on position to potentially gain 300 USD, the risk to reward ratio is 1:3.

Ratio of 1:2 is considered the minimum one should aim for as only a third of positions would need to be profitable to remain break even.

Potential profit and loss can be defined through Stop Loss and Take Profit levels.

Stop Loss and Take Profit are orders to close the position when price reaches a certain predefined level. Stop loss or Take Profit level can be identified with various technical analysis tools:

  • Support and resistance: for a short position stop loss is usually placed just above resistance level, while a long position often has stop loss set a little below support level.
  • Trend lines and channels: stop loss price is commonly placed outside the channel, above or below the trend line. 

The upside

If you trade with an appropriate amount of leverage, restrict your risk-per-trade to no more than 2%, size your positions appropriately and never open more than a couple of positions at any one time, it is nearly impossible to receive a margin call. Proper risk management is the difference between successful trading and gambling. Perfect risk management and you will be well on the path to becoming a profitable and successful forex trader.

Risk management and margin call avoidance

Leverage is often and fittingly referred to as a double-edged sword. The purpose of that statement is that the larger leverage a trader uses – relative to the amount deposited – the less usable margin a traderwill have to absorb any losses. The sword only cuts deeper if an over-leveraged trade goes against a trader as the losses can quickly deplete their account.

If there’s one thing all successful traders have in common it’s ensuring they take a structured approach to managing risk as part of their trading plan.

When will my positions get closed?

Typically, there are three scenarios in which your positions will get automatically closed. However, we can’t always apply this protection and you shouldn’t rely on us doing so.

  • If your equity drops beneath 50% of your margin requirement
  • If you remain on margin call constantly for 24 hours
  • If you are on margin call during periods of increased volatility, or periods when we anticipate increased volatility

Our margin requirements are subject to change. If they increase on one or more of your positions then your current equity may not be enough to keep positions open.

Finally, it is important to remember that we could close you out at any time when you are on margin call. It is your responsibility to have enough funds on your account to fully cover the margin requirement of your open positions

Top 4 ways to avoid margin call in forex trading:

  1. Do not over-lever your trading account. Reduce your effective leverage. Recommend ten to one leverage, or less. 
  2. Exercise prudent risk management by limiting your losses with the use of stops.
  3. Keep a healthy amount of free margin on the account in order to stay in trades. 
  4. Trade smaller sizes and approach each trade as just one of a thousand insignificant, little trades.

In the case of managing risk, correct position sizing is critical.

This means achieving the correct exposure on each position relative to the size of your account and taking the time to understand how volatility and the recent moves in price affect how much risk you’re prepared to take.

Other tools to manage your risk

Before you start your trading journey, you can:

  1. Use a stop-loss to define your risk exposure. A stop-loss is a great tool to manage risk and should be seen as an essential part of a trading process. A great trader won’t necessarily judge the trade by profit or loss, but by how they went about following their set process from start to finish
  2. Find out more about calculating position sizing. You’ll be able to do this using the Calculators tool in your client area
  3. Practise on a demo account with virtual funds in real market conditions.

Once you feel confident in your ability to assess and manage risk, you’ll feel more confident in your trading and will be in a better position to achieve more consistent capital growth in your trading account.

Five Simple Tips Protect Against Margin Calls

The golden rule to handling margin calls is not to get there in the first place. The following are tips to prevent you ever getting into a margin call situation.

1. Lower leverage

While margin trading can increase profits, it also elevates risk by the same amount. Traders who aggressively leverage their accounts are far more likely to receive margin calls than those that don’t.

2. Understand the product

Trading in products that are not fully understood is a common reason for receiving an unexpected margin call. The pricing of many financial products, especially derivatives, can be erratic especially at times of change such as rising or falling volatility, risk aversion, and changing interest rates.

3. Beware of liquidity and event risks

Times of reduced liquidity and/or increasing volatility can greatly increase the chances of a margin call. That means holiday periods and throughout economic events like critical interest rate decisions and important elections. At these times, minimum margin requirements can increase suddenly and without notice.

4. Stop losses

Stop losses are a useful means for managing losses but they won’t always protect against adverse market conditions particularly when liquidity dries up. The stop losses should be placed well above the thresholds where a margin call becomes imminent.

5. Check regularly

A margin call can often be avoided simply by managing the account effectively and following good risk control, for example using VAR. It’s always better to be on top of a situation before it gets out of your control rather in than the hands of the broker.

Margin call FAQs

What is margin call for a short position?

Margin call for a short position is triggered if the asset you’re selling appreciates, or moves against you. You’d then be required to deposit additional capital into your account to reach the required maintenance margin level.

What does CFD margin call mean?

CFD margin call means the same as it does for any leveraged derivative, that your account balance has fallen below the required level to maintain your position. If you don’t top up your CFD account with more funds or reduce your position to release funds from the margin, your positions could be closed.

What is margin call in forex?

Margin call in forex is when the market has moved against your position and your margin indicator lever goes below 50% of the margin required to maintain your position. At this point, your position could be closed unless you top your balance up again. Margin calls are more common in forex as the market is more volatile, meaning your account value can change faster.

The Bottom Line

Buying on margin isn’t for everyone. While it can give investors more bang for their buck, there are downsides. For one, it’s only an advantage if your securities increase enough to repay the margin loan (and the interest on it). Another headache can be the margin calls for funds that investors must meet.

A margin call may require you to deposit additional cash and securities. You may even have to sell existing holdings. Or you may have to close out the margined position at a loss. Since margin calls can occur when markets are volatile, you may have to sell securities to meet the call at lower than expected prices.

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