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Forex margin calls are the alerts in Forex trading that indicate the need to deposit more money on your account or to close the losing positions. The mentioned processes take place when the value of a trader’s margin account drops under the broker’s demanded quantity.
It should be said, that there are two types of accounts – a cash account and a margin account. If you have a cash account the margin call won’t happen to you, but if you have a margin account then there’s a risk that it will happen to you. In this guide, you’ll get detailed information about how margin call works, what is margin level in Forex and how to avoid the margin call.
Margin Call Explained in Layman’s Terms
What’s exactly the margin call? Who exactly is calling you or what exactly is occurring? The word call in the margin call doesn’t necessarily mean that you get a phone call or anything like that. It could in some situations, but this is, first of all, coming from your broker. So, whoever your broker is, whoever has your account, they’re making a call to you not necessarily in a sense of picking up a phone and calling you or texting you or anything. But why they are calling you? What is the purpose of the call?
The purpose of the margin call in Forex, the reason why the broker is getting a hold of you or taking a form of action, is because your risk is just totally out of control. Whats does that mean that risk is being out of control? This most commonly occurs when you’ve gone short a position. Going short in a nutshell just means that you’re making money when prices go down. The risky part of short selling though is because a price can theoretically go forever, your risk, the amount of money you lose is also unlimited. That’s because the price can go up and up forever, whereas on the flip side a price can only go down as far as zero.
When you have a margin account, your trade is essentially a loan. There is a loan dynamic going on and because of that, the person making a loan, your broker is taking on different forms of risk meaning that they are gonna have systems in place to make sure that the risk doesn’t get too far out of control. After the risk is getting out of control you get a margin call. Getting a margin call means that you have to deposit more money on your account to continue the trading process or you just have to close the losing positions.
Margin Call Example
To make it more clear what a margin call means, there should be taken a concrete example, which will support you to understand the mentioned phenomena. Firstly, it should be said, that until you start trading the broker gives you information about margin requirements. The margin requirement diversifies among the brokers and you can choose among them the most suitable and preferred one.
So, let’s say that the balance on your account is $5000. You want to take a short position for the USD/JPY currency pair. Imagine that the lot size, in this case, is 1 lot and the margin requirement is 3%. That means that the broker takes $3000 from your balance, as long the 1 lot size is equal to 100 000 currency units. Here it should be mentioned free margin. What is free margin in Forex? Depending on the above-mentioned example the free margin will be $2000 the amount of money you owe without taking trading processes or without any loss or profit. Assume, that you started trading and opened your position, you’re going short and you think that price is going down, so you can make a profit. But it occurred that the price went up. Let’s say, that prices went so up that you lose $2000, which means that the amount of free margin equals zero. At this moment you left $3000 as equity. It may seem that you left the mentioned amount of money to continue trading, however, remember, that you agreed broker give him $3 000 as a fee. Here is one main thing that should be considered. This is the margin level. What is margin level in Forex? The margin level shows the ratio between available equity and used margin, depending on the example will be 100%. So, at this moment, when you already exhausted your available resources to use while trading, the broker sends you a margin call. The broker asks you whether you are going to deposit a certain amount of money to continue the trading or to close the position and liquidate the trade.
Differences Between Margin Call Level and Margin Calls
Margin call level and margin calls are the things, that often distract the traders. To make it more clear it’s important to show what are the differences between the two above-mentioned things.
The margin call is an alarm, which occurs after reducing funds and rising risks and includes the process of the broker notifying you to make a deposit on your balance or cut the losing positions. While a margin call level is a concrete point of the margin level Forexwhich leads to the margin call. A margin call happens after you go below the point of the margin call level, which is defined in advance until you start trading. So, as you see, even though that the two mentioned terms are highly linked and connected, they are not still the same.
Ways to Avoid a Margin Call
When the margin call happens it requires the trader to fill up his balance and deposit a certain amount of money on his account, which leads him to raised costs. Also, as we already mentioned margin call may lead a trader to stop his losing positions, so in any case, when the margin call occurs it leads the trader to money loss or additional costs. There are some ways to avoid the margin call. However, until going into depths and describing the above-mentioned ways, it should be said, that some brokers furnish traders with the negative margin Forex. Negative margin Forex means that even though you reached a certain margin call level you can continue trading by loaning the money from the broker. However, that’s not always what happens and in most cases, the brokers don’t allow you to go negative margin.
One of the main ways to avoid the margin call happening is not to over-lever your trading account. That means that you have to reduce effective leverage and trade through the lower leverage, which will support you to save your money and prevent the margin call to occur.
Furthermore, another way is to generate risks and manage them. Through risk management, you can limit your losses with the use of the stop loss/take profit feature, which is available on almost every trading platform.
Moreover, for avoiding the margin call it’s essential to define a healthy amount of free margin while trading. This means, that you have to set a certain amount of money which shows your readiness to risk while conducting trades. Most recommended is the 1% which allows you to reduce maximally your losses and focus on other trading issues.
Besides, for preventing the margin call it’s important to trade smaller sizes. While trading smaller sizes there is a smaller chance to lose your funds if the processes won’t go the way you want or predict.
Final Words
In this article, you got the information about what does margin call mean, how it works, what are the main things to consider for avoiding the margin call to happen, and so on.
Long story short, let’s say once again, that a margin call is a certain type of alert which comes from the broker and indicates the raised risks, which follow to additional costs and money loss. Besides, there are several ways to prevent margin call from occurring and supports them to save their money.