What is margin call in trading?
A margin call in trading is a situation that occurs when the account equity (the current value of your account including open positions) falls below a certain level specified by the broker, known as the "margin call level" or "maintenance margin level." When this level is breached, the broker issues a margin call to the trader, typically as a warning message, indicating that the account is at risk of having insufficient funds to cover potential losses on open positions.
Here's a step-by-step explanation of how a margin call works:
Initial Margin: When you open a trading position, you are required to deposit an initial margin with your broker. This initial margin serves as collateral and ensures that you have enough funds to cover potential losses on the trade. The initial margin is a percentage of the total position size and varies based on the leverage and trading instrument.
Used Margin: As you open and maintain positions, a portion of your account balance is "used" as margin to cover the potential losses on those positions. Used margin ties up a certain portion of your account funds to ensure that you have sufficient collateral for your trades.
Maintenance Margin Level (Margin Call Level): Brokers set a maintenance margin level, which is a percentage of the used margin. If your equity falls below this level due to losses on your trades, a margin call is triggered. This level is set to ensure that you have a buffer of equity before your positions are automatically closed.
Margin Call: When your equity falls below the maintenance margin level, your broker will issue a margin call. This is usually a notification sent via email, platform alert, or directly within the trading platform. The margin call informs you that your account is at risk of having insufficient funds to cover the potential losses on your open positions.
Action Required: Upon receiving a margin call, you have a choice:
Deposit additional funds into your trading account to bring your equity back above the maintenance margin level.
Close some of your open positions to reduce the used margin and increase your equity.
The purpose of taking one of these actions is to avoid the account's equity falling further and potentially leading to a stop-out.
- Stop-Out (Margin Closeout): If you fail to take appropriate action and your equity continues to decline, reaching the broker's stop-out level, your broker will automatically close your positions starting from the position with the largest loss. This prevents your account from going into a negative balance, protecting both you and the broker.
Margin calls and stop-outs are crucial components of risk management in trading. They help traders maintain responsible trading practices and prevent excessive losses that could lead to financial difficulties. It's important to be aware of the margin requirements and levels set by your broker and to regularly monitor your account's equity and margin to ensure you're trading within your risk tolerance.