Margin Call and Stop Out: Definitions and Calculation Rules
A margin call and a stop-out are both trading conditions that should be mentioned account by the Forex brokers. This article covers both these topics, including their definitions, formulas, pros, cons, and ways to prevent them.
Defining Margin Call
A margin call refers to when the margin’s account value goes below the requirement in the account’s maintenance margin. The brokerage firm demands that both the values be leveled by bringing the former up. In order to meet a margin call, the investor would further take steps, such as make extra deposits or unmargined securities or liquidate the current assets.
The maintenance margin has been leveled up to 50% by Regulation T of the Federal Reserve. Several brokers keep it 30% or 40%. Brokers use these percentages to shield themselves from the danger of future customer default. It guarantees sufficient customer collateral on the margin account.
A brief grace time is given to the client to take the necessary steps to fulfill the margin criteria. When the customer is unable to satisfy the margin call, securities can be sold by the broker to meet the subject level.
The Financial Industry Regulatory Authority and other authorities allow brokerages to put up margin restrictions for Forex accounts. FINRA has leveled it at 25%. It is not necessary for the broker to issue a margin call if the account goes below the required number. This, in turn, motivates the other party to top up the amount in the account. They can also sell a portion of the client's shares without alerting the customer to return the margin account to the maintenance margin.
Formula for Calculating the Margin Price
Use the following formula to calculate the margin price level:
Margin Price = Initial Purchase Price x (1 – Initial Margin) / (1 – Maintenance Margin)
Defining Stop Out
A stop out level refers to a particular needed margin level in percent at which a trading platform will begin to automatically close trading positions (starting with the least profitable position and continuing until the margin level requirement is met) to prevent further account losses into the negative territory–below 0 USD.
Stop Out Formula
The following formula may be used to determine the margin maintenance rate (percentage), which is the trigger condition for stopping out.
Stop Out = Total Available Margin/ Margin Requirements x 100
Where the total available margin equals the sum of the FX account balance plus any valuation gain or loss incurred while trading. The greater this figure is, the better the margin maintenance rate will be.
The greater this figure is, the better the margin maintenance rate will be.
100% Margin Call and Lower Margin Calls & Stop Outs: Pros and Cons
The advantages include:
- Stopping at a 100% margin saves traders a substantial amount of money when losses are unavoidable.
- Having a low 10 percent margin requirement pushes the danger of a margin call further away.
- The 100 percent margin requirement takes care of the last stage of money management for you, ensuring that you don't lose your last short if you can't handle it yourself.
The disadvantages include:
- A 10% margin requirement necessitates a thorough understanding and management of one's account equity and margins.
- Stopping at a 10% margin only saves a few bucks on the doomed account.
- 100 percent margin need indicates that the margin call is approaching quickly.
How to Avoid Stop Outs and Margin Calls
At the very minimum, use these techniques:
- Select the leverage with care. If you go with lesser leverage, be sure you have enough money to initiate and close transactions. If you pick more leverage, be sure you don't take on more transactions than your account can manage.
- Minimize your risks. Control the number of lots exchanged at any one moment. Keep an eye on the required and available margin in your account statistics.
- If you're not sure what the figures in your account signify, look for additional educational information on the subject.
- Use stops to safeguard your investment from large losses.
If you're in difficulty and on the verge of a margin call, consider:
- Increasing your leverage,
- Adding additional money to your account,
- Closing unsuccessful transactions before the platform do it for you
- Hedging those trades if you know how to get out of the hedged trades afterward (requires experience).
By holding several types of assets, an investor can diversify their portfolio. Stocks, bonds, commodities, and derivatives are examples of financial goods. A diverse portfolio can help investors weather the financial markets' ups and downs without falling below the maintenance buffer.
All of these techniques will postpone the margin call, but you'll still need to handle your lost trades before they cause further losses.