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 a clear border 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. For many people, trading on margin is one of the biggest motives to trade Forex. With Forex, you do not actually need $100,000 to trade $100,000 worth of currency. You might need, for example, only $1,000 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.
Crucial to understanding of when a margin call or a stop-out may be issued on your account is the concept of a margin level. A margin level is your account's equity divided by your account's used margin:
Now when you join a Forex broker, you will read about their margin call and stop-out procedures, and you will 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 that you are required to maintain in your account, you will 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 are safe for now (but really should close out your trades as soon as possible and return to a demo account). If on the other hand you do not, 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 will hit the stop-out level. At this point, your trades will be closed automatically by your broker starting at the ones that are failing 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 will 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 is there does not 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 are 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 are truly ready.
Some 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 the 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 the 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 a margin call will be issued. When your loss on that position 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 a stop-out.
Example 3. You have a $5,000 account at a broker with 150%/100% margin call and stop-out levels. You open a trade using $1,000 margin. You would get a margin call when your loss on that trade reaches $3,500 (so your equity is $1,500 or 150% of your $1,000 used margin). You would get stopped out when your loss reaches $4,000 (so your equity is $1,000 or 100% of the $1,000 used margin). However, if you opened a bigger trade, using your whole account size ($5,000) as margin, you would get a margin call immediately, and since stop-out is 100%, you will not be even able to open that position, or otherwise, it would get closed out instantly, since you have to maintain at least $5,000 equity in your account.
Three Important Notes
- The amount of used margin for position maintenance does not depend on the stop-out level. It only depends on the trade size, leverage, and the broker's margin requirements. For normal Forex trades, it is usually just the trade size divided by the leverage. For example, 0.1 lot on EUR/USD at 1.1000 with 1:100 leverage will require 0.1 × 100000 × 1.1000 ÷ 100 = $110 margin.
- The margin call and stop-out mechanisms do not completely prevent the possibility of an account balance becoming negative due to the losses on open trading positions. In rare cases, it is possible for such a situation (when account balance goes below zero) to appear in Forex. A notable example is January 15, 2015, Swiss franc gap that resulted in EUR/CHF positions closing hundreds pips below the stop-losses and stop-outs failing miserably. However, normally, brokers only seek redemption on very large negative balances as it is quite difficult for them to make the account holder compensate the loss.
- It is important to remember that margin call and stop-out levels are defined in relation to margin and equity, not to loss and equity. So, it is impossible to tell the exact loss level when any of those levels will trigger without knowing both the amount of used margin and the equity of your account.
