What Does a Margin Call Mean?
A margin call occurs when the value of a trader's account falls below the minimum amount required to maintain their open positions. This minimum threshold is often referred to as the "margin maintenance level." When this level is breached, the broker may notify the trader, prompting them to take action to restore the account balance.
While this notification used to come via phone calls, in today’s digital world, brokers typically send emails or app alerts. However, the significance of the message remains unchanged: your account is at risk.
Margin Level and Margin Call: Key Differences
Understanding the distinction between "margin level" and "margin call" is crucial for traders.
Margin Level: This is a percentage that represents the ratio of your account's equity to the margin being used for open trades. It fluctuates with market conditions and your account’s performance.
Margin Call: This is an event triggered when the margin level falls below a pre-defined threshold set by your broker.
Think of it as operating a vehicle:
The margin level is your fuel gauge, showing how much fuel you have relative to your journey.
The margin call level is the "low fuel" warning light, alerting you to take immediate action.
A margin call is the equivalent of your vehicle coming to a stop because you ran out of fuel entirely.
Example: Margin Call in Action
Imagine you're trading stocks, and your broker requires a 20% maintenance margin. You deposit 10,000 units of your local currency and use half of it (5,000 units) as margin to open a position.
Initially, everything looks good. However, the market moves against you, and your open positions incur losses, reducing your equity. If your equity falls to 20% or less of the margin being used, the broker will issue a margin call. For instance:
Initial Equity: 10,000 units
Used Margin: 5,000 units
Equity after Losses: 1,000 units
Your margin level is now calculated as:
Margin Level=(Equity/Used Margin)×100%=(1,000/5,000)×100%=20%
Margin Level=(Used Margin/Equity)×100%=(5,000/1,000)×100%=20%
Since the margin level has hit the maintenance threshold, a margin call is triggered.
What Happens Next?
Upon receiving a margin call, traders generally have two options:
Deposit More Funds: Adding more funds increases the account’s equity, raising the margin level above the maintenance threshold.
Reduce Open Positions: Closing some trades can free up margin, improving the margin level.
If no action is taken and losses continue to mount, the broker may forcibly close positions to prevent further losses. This process is often referred to as "liquidation."
Beyond Margin Calls: The Stop-Out Level
If the margin level continues to deteriorate despite a margin call, it may eventually reach another critical point called the "stop-out level." At this stage, the broker automatically begins closing positions to preserve account equity. This threshold is typically lower than the margin call level and varies by broker.
For example, if the stop-out level is set at 10%, your broker will liquidate positions once your margin level drops to or below this value.
A Practical Analogy: Margin Calls in Everyday Life
Think of trading on margin like renting a workspace:
You must pay a deposit (initial margin) to secure the space.
If damages occur (trading losses), your landlord may require additional funds to keep the lease (margin call).
If damages exceed a certain limit (stop-out level), the landlord might terminate the lease and reclaim the space (forced liquidation).
Conclusion
Margin calls are a safeguard mechanism to ensure that traders can sustain their positions without exposing themselves—or their brokers—to excessive risk. While they can be alarming, understanding how they work and taking proactive steps to manage your account can help you navigate the challenges of leveraged trading with greater confidence.
For more on managing risk and maximizing trading efficiency, explore lessons on risk management and account maintenance in your trading journey.