What are Stop Out and Margin Call?
Forex transactions are never without a certain risk. To prevent a negative balance on the trader's account, each broker has Margin Call and Stop Out levels. In this article we will learn what they are, how they work and how to calculate them correctly.
Margin Call is the forced closure of one or more trader's positions without prior notice if the current level of equity is less than 50% of the margin required to maintain open positions.
Margin Call is a warning that the equity is running out on the trader's account. In this case, they need to either make a deposit or close one or several positions manually. The broker also has the right to close especially unprofitable trades after notifying the client if the balance situation does not improve.
It is important to take into account that the broker is not obligated to warn the trader about the closure of orders by Margin Call. Carefully study the trading conditions in order to learn what the broker can do in such a situation.
Stop Out is a forced closure of one or all positions by the server as soon as the level of equity reaches a specified level (for example, 10%) or becomes less than the margin required to maintain open positions.
In case of Stop Out, the closing is done automatically by the trade server, starting from the most unprofitable position. Stop Out is necessary so that the client's trading account balance does not go into a negative territory. Any negative balance on the trading account is covered by the broker's funds.
Usually the Margin Call level is at 50-100%. The Stop Out level is usually lower than the Margin Call at 10-30%.
For some brokers, the Margin Call and Stop Out levels may be the same, which means the broker will begin to liquidate the least profitable positions without warning.
How does the broker warn traders about Margin Call?
In MT4, when a Margin Call situation occurs on a trading account, the terminal highlights it automatically. You will not be able to open new positions due to the lack of available funds. In addition to the warning in the terminal, many brokers notify the client about the possible consequences of the Margin Call by phone or email.
How do you monitor the Margin Call and Stop Out level?
One of the most important sections of the information menu in MT4 is the “Trade” tab in the Terminal window. In the fields Balance, Equity, Margin, Free Margin, Margin Level you can see the current value of these indicators on your trading account.
Balance is the amount of funds on the client's account inclusive of all previously closed positions. In the screenshot, the balance is equal to RUB 6,427.53
Equity is the amount of funds on the client's account inclusive of the profit or loss on the current open positions. Equity calculation formula:
Equity = Balance + Floating Profit - Floating Loss + Bonus funds or Credit (if any)
6,427.53 - 97.24 = 6,330.29 RUB
Margin is the amount of funds required to maintain open positions.
Margin size is influenced by the leverage, the volume of the open position and the type of account.
The higher the leverage, the lower the Margin required to maintain positions. For example, with a leverage of 1:100, margin is 1% of the required amount, with a leverage of 1:500 - 0.2%. The volume affects the margin size in the opposite way: the larger the position volume, the higher the margin required to maintain it.
The maximum available leverage may be limited depending on the type of account and the trading instrument. All the information about each traded asset can be found in the broker's contract specifications in the MT4 terminal. The formula for calculating the Margin is as follows:
Margin = Position Volume x 1 Lot Size x Currency Pair Rate / Leverage
In our example, we have the following values:
Leverage - 1:200;
Trading instrument - NZD/USD;
2 trades with a volume of 0.01 lots - 0.02 lots;
Account type - ECN;
Contract size - 100,000 NZD (as a rule, 1 lot is always equal to 100,000 units of the base currency)
We calculate the margin for each separate open position:
0.01 x 100,000 x 0.71020 / 200 = 3.551 USD – Margin for the first position
0.01 x 100,000 x 0.71038 / 200 = 3.5519 USD — Margin for the second position
We convert it into the account currency: 3.551 + 3.5519 = 7.1029 USD = 527.27 RUB
The exact figure may vary slightly due to changes in exchange rates.
It should be borne in mind that if the account deposit is in the same currency as the base currency, there is no need to multiply by the rate of the currency pair. For example, when opening a 0.01 lot position in the USD/CHF, where USD is the base currency, with the same leverage, the margin would be 0.01 x 100,000 / 200 = 5 USD
Free Margin - the amount of free funds available to open new positions and maintain drawdowns on already opened positions. Free Margin is calculated using the formula:
Free margin = Equity - Margin
6,330.29 - 527.76 = 5,802.53 RUB.
Margin Level is an indicator that reflects the ratio of all funds on the account to the margin value in percentage. The Margin Level is calculated using the formula:
Level = Equity / Margin x 100%
6,330.29 / 527.76 x 100% = 1,199%
Margin Level is the indicator the server uses for Margin Call and Stop Out. Let's say Margin Call is 100% and Stop Loss is 30%. In this case, it will trigger when the Equity value equals the Margin value. If the equity falls to 30% of the margin, Stop Out will occur.
As we can see from the formula, the Margin Level value depends on the Equity and Margin parameters. The larger the current floating loss on open positions, the lower the Equity value. On the other hand, the higher the total volume of open trades, the higher the Margin parameter. In other words, the two main factors that affect the Margin Level are floating loss and trade volume.
It is important to know that leverage also affects the margin, however it rarely changes without the participation of the trader.
How to avoid Margin Call and Stop Out?
The main rule that every trader should follow in order to avoid Margin Call and Stop Out is to limit losses. Do not try to wait out the drawdown on open positions. Orders with floating loss should be closed as early as possible.
Don't open many trades. The more open trades, the less free margin remains on the trading account. If traders want, for example, to hedge trades in order to limit potential losses, they may not have enough margin to open new positions.
To control the level of possible losses on open positions, it is recommended to use the Stop Loss order. This is especially useful during periods of high market volatility, such as the opening or closing of trading sessions.
You should only trade for the amount that you can afford to lose. A common practice among experienced traders is to trade with no more than 5% of your balance.
If the Margin Call has already occurred, to avoid Stop Out you need to close the most unprofitable positions. You can also increase your leverage if possible or make a deposit to your trading account.
If you decide to trade using a risky strategy, you can always test it on demo accounts first. Remember that only a competent approach to deposit management and a reasonable level of risk will help you preserve and increase your capital.
Article last updated: 2022-10-28