Stop-Out Level vs. Margin Call
admin on September 15th, 2011
When choosing a Forex broker and planning to open your first account, you will probably hear a lot about stop-out level, margin call, and leverage. While many brokers will only talk about margin calls, others seem to delineate between margin calls and stop-out levels. What is a stop-out level, and what is the difference between a stop-out level and a margin call?
To start with, let’s quickly review the definition of margin. Trading on margin is one of the biggest motives to trade Forex for many people. With Forex, you don’t actually need $100,000 to trade $100,000 worth of currency. You might need for example only $1000 if your broker offers you leverage of 1:100. This means that for every dollar you put down in your deposit, you are allowed to trade $100 worth of currency. This is referred to as trading on margin. It is incredibly powerful and can make you rich overnight—or destroy you overnight, which is considerably more likely!
You can rephrase the 1:100 leverage above as 1% margin. This means that the broker requires you to present 1% of the trade as a minimum security margin. Now when you join a Forex broker, you’ll read about their margin call and stop-out procedures, and you’ll usually see some percentages which refer to your equity. For example, a broker may list a margin call at 20% and a stop-out level at 10%. What this translates to is that if, during the course of a trade, your account equity drops to 20% of the margin which you are required to maintain in your account, you’ll get a margin call. In the case of this kind of broker, this will usually be nothing more than a warning and a strongly worded suggestion that you close some or all of your trades, or deposit more money to meet the minimum margin requirement. If you do these things and all is well, you’re safe for now (but really should close out your trades as soon as possible and go back to demo testing). If on the other hand you don’t and you stay in the trades and they go further against you, your equity may drop to 10% of what is required, at which point you’ll hit the stop-out level. At this point your trades will be closed automatically by your broker starting at the ones which are failing the most badly. If necessary, all of your trades will be shut down in order to meet the minimum margin requirement.
Another way of doing things is a margin call at 100%. That means once your equity drops below 100% of the minimum requirement to trade, you’ll not only get a margin call, but your trades will be closed out just like at a stop-out level. This combined system contains no warning—it simply closes your trades.
How do you avoid this horrible thing happening to you? To avoid getting a margin call and/or hitting a stop-out level, you should only trade what you can afford. Manage your money in a rational manner; only use leverage if it makes sense for you to do so. Just because it’s there doesn’t mean you have to use it! A lot of profitable traders—most actually—only trade about 2.5–5% of their own equity. There is nothing wrong with doing it this way—you’re more likely to make it in the long run. And if you do hit a stop-out level or get a margin call? Go back to demo testing until you can trade profitably again, and then get back to live trading when you’re truly ready.
Some More Real Life Examples:
Example 1. You have an account with a broker that has 50% margin call level and 20% stop-out level. Your balance is $10,000 and you open a trading position with $1,000 margin. If the loss on a position reaches $9,500, your account equity becomes $10,000 — $9,500 = $500, which is 50% of your used margin, the broker will issue a margin call warning. When your loss on a position reaches $9,800 and your account equity becomes $10,000 — $9,800 = $200, which is 20% of the used margin, the stop-out level will be triggered and the broker will automatically close your losing position.
Example 2. A broker has 200%/100% margin call and stop-out levels. Your balance with it is $1,500. You open a trading position with $200 margin. If the loss on this position gets to $1,100, your account equity becomes $1,500 — $1,100 = $400, which is 200% of your used margin, then the margin call will be issued. When your loss on that position then reaches at least $1,300 and your account equity becomes $1,500 — $1,300 = $200, which is 100% of the used margin, your position will be closed automatically by stop-out.