All You Need To Know About Margin Calls

A lot of traders must have been coming across this topic- Margin Calls but do not really have in-depth knowledge on this topic. Some, however, must have heard of it but want to know more on this topic.

If you fall under any of these categories, stick around till the end of this article as this topic would properly be demystified for you!

What Is Margin Call?

A margin call happens when the percentage of a trader's equity in a margin account falls below the broker's required amount. In a margin account, traders combine their own money and borrowed money from their broker to trade the market.

When a margin call happens, it means that the value of the trades held in the account has reduced.

In response to tragic news such as margin calls, traders only have two options. They can choose to deposit more money or marginable securities into the account, or they can sell some of the assets already held in their account.

What Makes Margin Calls Happen?

When you are buying and selling securities using your own money and some borrowed from a broker, that is called buying on margin. 

Your equity in the investment is the market value of the trades minus the borrowed amount.

The NYSE and FINRA, which is the regulatory body for many securities firms in the US, both have a rule that investors/traders must maintain an equity level of at least 25% of the total value of their securities when buying on margin.

That is the minimum they want you to have in your trading account.

But note that, some brokerage firms might have even higher requirements, like 30% to 40%.

Margin calls usually happen during periods of market volatility. When the market gets all crazy and unpredictable, such as during news releases, it can affect the value of your trades, which might cause your equity to fall below the required level. That is when the margin call alarm goes off!

This tells you the importance of keeping an eye on your account and be prepared for potential margin calls, especially during volatile times.

Typical Example Of Margin Call For Forex Traders

Let's say you decide to trade the EUR/USD currency pair with a leverage of 1:50.

You have $2,000 in your trading account, and you decide to open a position of 1 lot (100,000 units) on the EUR/USD at an exchange rate of 1.2000.

With a leverage of 1:50, you only need to put up $2,000 as margin to control a position worth $100,000. The remaining $98,000 is borrowed from your broker.

Now, let's say the exchange rate moves against you, and the EUR/USD drops to 1.1500. The value of your position has now decreased to $115,000 (100,000 units x 1.15 exchange rate).

Since your borrowed amount remains the same at $98,000, your equity has decreased to $17,000 ($115,000 - $98,000). As a percentage of the total market value of your position, your equity is now 14.8% ($17,000 divided by $115,000).

Notice! This falls below the required margin level set by your broker. This then triggers a margin call, and your broker asks you to deposit additional funds to bring your equity back up to the required level.

If you fail to meet the margin call and don't deposit more funds, your broker may liquidate part or all of your position to cover the borrowed amount. This is to protect themselves from potential losses.

So, how can you cover Margin Calls?

How To Cover Margin Calls

When you receive a margin call, there are two things you can do.

  1. Deposit some cash: You will have to add some money into your trading account to meet the margin call.
  1. Close other open trades: Another option is to close some or all of your running trades.

How to avoid a margin call

There are a few steps you can take to manage your account wisely.

Here are what you can do:

  1. Put into consider the need for you to open a margin account: Before opening a margin account, think about whether it is important for your investment goals.

Long-term traders usually do not need to use margin to achieve solid returns. Remember, margin loans come with interest charges.

  1. Diversify your portfolio: Building a well-diversified portfolio can help reduce the risk of margin calls.

When your investments are spread across different assets, a decrease in the value of one currency pair won't have a significant impact on your overall euqity.

  1. Monitor your positions and account regularly: Stay on top of your open positions, equity, and margin loan. It is a rule of thumb to check in on them regularly, maybe even daily, to ensure you are aware of any changes or potential risks especially if you are a swing or position trader.
  1. Set alerts: Create alerts that remind you when your account reaches a certain level above the margin maintenance requirement.

By doing this, if eventually your account value falls to that level, you can quickly deposit money to increase your equity.

Conclusion

In summary and for final recap, it is very important for traders to understand margin calls when dealing with the ups and downs of the forex market.

When the amount of money you have in your margin account falls below what your broker requires, you will get a margin call. It is important to act quickly when this happens.

Market changes can make things even riskier, so it is necessary to keep a close eye on your investments. If you do get a margin call, you have options like depositing more money or selling running trades.

Managing your account wisely, diversifying your investments, and being responsive are key to avoiding margin calls and building a strong investment strategy.

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