The leading cause of Margin Call is not from an inaccurate system or an unsupportive broker. Believe it or not, the source originates from the traders themselves.
Margin Call (MC) is a warning system that is activated once your equity is nearly insufficient to sustain any more losses. If the loss position continues to increase and the equity value has decreased far from the margin requirement, the broker will close part of the position until the margin requirement is met again. The closing of this position is called Stop Out. That's why most traders misplace the meaning of Stop Out and Margin Call.
This interchangeability of terms arises from a trader's lack of knowledge in understanding the intricacies and terms of foreign exchange trading. It is important to note that brokers have various policies regarding Margin Call and Stop Out levels. Some brokers even set their Stop Out and Margin Call levels at 100.
- How Does It Work?
- What Causes Margin Call?
- Several Tips to Avoid Margin Call
How Does It Work?
Suppose an available margin (free margin) runs out, we will receive a Margin Call as a notification from the broker. It is a notification to increase the deposit of funds because the existing margin is insufficient to hold the trading position. If you do not deposit funds immediately, the trading position will be forcibly closed by the broker. If you were getting hit by a margin call, it usually means your account cannot be saved anymore because your funds have run out.
What Causes Margin Call?
The significant losses that can bring Margin Call, in general, comes from a trader's lack of self-awareness of his weaknesses. Therefore, not being aware of ourselves is a dangerous thing. There are four significant factors that cause Margin Call:
Let's say you just made a hefty profit. Congratulations!
What are you going to do next? If you're about to open bigger positions just because you feel like it, then you're getting carried away by your overconfidence.
It's best to stay disciplined with your Money Management. The tendency to open more positions after getting profit is a risky action that can eventually lead to Margin Call. Some traders feel very lucky when they have just made a profit and feel that the market is on their side, then 'bet' their capital by opening a new, large-scale position.
Self-confidence can make traders too brave to open positions, even when their analysis is sometimes not following market conditions. Usually, a trader who is affected by this sickness will continue to hit the game according to his belief, even though the result is negative floats. Sooner or later, overconfidence will be the cause of Margin Call.
Overconfidence is usually followed by overtrading. When opening a position based on emotion, traders tend to not pay attention to the market analysis. If they end up in the wrong, they will be even more curious and open a new position, this time with an immense volume. If you experience such situation, it means that you have contracted the overtrading sickness.
3. Trading without Stop Loss
A trader who lets his positions closed with a considerable amount of loss can experience a Margin Call cumulatively. More enormous losses will slowly eat up the free margin and eventually leads to Margin Call.
4. Lack of the Funds
Many foreign exchange brokers allow traders to trade with a minimum deposit. This rule sounds very attractive to novice traders but very dangerous in practice. If your funds are too small for the risk target that you set, trading even with small lots can quickly run out of free margin.
Trading on margin can make you look great if you win the trades, but it may also lead to disaster if you lose money. Margin Call is like a ticking time bomb, and most brokers are unlikely to extend the deadline. If you did not pay attention to your margin level, you will fall into despair as the broker's notification reminds you that your equity has run out.
Several Tips to Avoid Margin Call
In terms of trading psychology, we do not want to admit our own mistakes in doing some analysis, which can have dire consequences in the future. Injecting funds after a Margin Call is only helpful if we are sure the price will reverse in direction. However, what if the price continues against your trading position? If this happens continuously, injecting funds is no longer a reliable solution to significant losses. And so, prevention is better than cure. Here are several tips to avoid Margin Call:
1. Choose Major Currency Pairs
You should choose major currency pairs such as EUR/USD, USD/JPY, GBP/USD, USD/CHF, etc. especially if you're a beginner. Major currency pairs have low spreads and high liquidity, making it easier to avoid Margin Calls caused by unexpected volatility.
2. Consider Hedging
To avoid Margin Call, you also need to learn about hedging strategy to place two positions in opposite directions simultaneously. For example, when you are suffering a loss from a Buy position, you can a Sell position on the same pair in hopes to offset the amount of loss from the Buy order. Hopefully, you can then decide to close one of these positions when the direction of the price trend is more confirmed. Hedging can also be done in certain correlated currency pairs.
Keep in mind that the correlation factor between currency pairs in foreign exchange is essential to note, especially for beginner or newbie traders. If you misunderstand the correlation, it will only increase the risks of your positions. For example, buying EUR/USD and GBP/USD at the same time will increase the risk except maybe at certain times.
3. Pay Attention to the Amount of Equity
To avoid Margin Call, you should always be aware of your equity. If it is not possible to open a position, it is better to get out of the market. Beginner traders tend to follow their emotions when looking for a possible trade. They pay no attention to the equity they have.
4. Control Your Emotion
You will not overreact to a losing position if your emotion is in control. You will not be eager to "look for makeshift opportunities" for revenge, which in turn can lead to overtrading and increase the risk of Margin Call. On the other hand, you will be able to accept the situation with a cool head, make evaluations, and try to re-enter the market according to your plan.
5. Use Risk Management
Implementing risk management also means that you are aware of the available funds in your trading account and make a realistic move to prevent losses. If your remaining funds are too tight to open a new position and pay the spread from that position, you should not hesitate to Cut Loss on a losing position before the loss erodes your equity and triggers a Margin Call.
6. Don't Be Greedy
Making huge profits in a short period of time, who would not want that to happen? However, this is the biggest mistake traders often make. Opening too many positions or placing big lots is a perilous action. In order to avoid Margin Calls, greed is something that must be removed from your trading habits. Getting big profits will always go hand in hand with a significant risk of losing.
7. Learn from Mistakes
Margin Call is experienced by almost all traders. In order to avoid repeated Margin Calls, keep evaluating your trading style. Even though it looks trivial, it is helpful to have a journal to monitor your trading progress. When keeping a trading journal, it does not have to be complicated. From there, you can trace what mistakes led you to the Margin Call.
Margins Call is a sensitive topic. Despite its scary nature, Margin Call is actually a savior for traders who are almost out of capital. It all depends on how you can manage your own risk. If you're able to control your emotion and stay disciplined to your trading plan, Margin Call is not an enemy that you should fear. If you still frequently experience Margin Calls, maybe now is the time to go back to deepen your basic trading knowledge.