What is Margin Call in Forex?
Margin Call is one of the worst nightmares that any Forex trader might have. Every Forex trader always hopes that they do are not made to face a situation where they have to encounter a Margin Call. However, before diving into the idea of Margin Call and understanding how to avoid them, it is important to understand what a Usable Margin is. The reason behind this is the fact that the value of the current Usable Margin determines whether the trader would have to face a Margin Call or not.
What is Usable Margin?
Usable Margin can be defined as the amount present as unused equity in the account of a trader. In other words, the equity amount present in the account of a Forex trader that is not being used currently for maintaining any open positions can be termed as the Usable Margin. This amount can be used to open or create new positions for trading. Usable Margin is also the amount or the extent that your current positions have the liberty to move against you before a Margin Call is made to you.
So, now that we have an idea of what and Usable Margin is, let us understand what a Margin Call is.
What is Margin Call?
In simple terms, Margin Call can be defined as a wake-up call or demand made by a broker to the trader or the investor asking them to deposit more securities or money into the account so that a minimum margin can be maintained. This usually happens when the value of one or more of the total securities in the traders’ account, which had been purchased with borrowed money, depreciates beyond a certain point. In such cases, the investors or traders are required to either deposit extra money to cover the deficit or sell part of the assets in order to cover the losses.
Hence, Margin Call is simply the call made to a trader asking them to push more money into the trade in order to continue trading further. This can be very devastating for the traders, and it is important to understand the causes so that such a scenario can be avoided.
What are the Causes of a Margin Call?
There can be a number of reasons that could lead to such a scenario. However, the top reasons that could lead to the receiving of margin calls include:
- Refusing to sell of a losing trade or securities for far too long when they should have been sold off long back. This often results in the depletion of the Usable Margin of the account.
- Leveraging the account excessively while holding on to losing trades for a long duration of time.
- Maintaining an account that has not been funded appropriately. This leads to trading excessively with very little to no Usable Margin.
- To put it in simple terms, undue leverage with insufficient funding while maintaining losing trades for lengthy durations are the main causes that lead to margin calls
Margin Call Procedure
So, what happens when a Margin Call takes place? In such situations, the trader is closed out or liquidated from their trades or securities. Hence, the trader is no longer allowed to maintain or hold on to their current positions unless they push in more money into their trades or their accounts. There are two main reasons for this.
- There is no longer adequate money in the trading accounts to hold the losing trades or positions.
- Due to the losses incurred by the trader, the broker is also deemed to incur great losses, and this is never good for the broker.
So, now that we know what a Margin Call is and what the causing factors are, let us see how a trader can avoid such situations.
How to Avoid Margin Calls?
There are numerous ways to manage trades efficiently and ensure that no Margin Calls are ever made. Some of these methods include:
Adequate monitoring of the trading account on a daily basis with the use of Stop-Loss orders that help to reduce the risks of losses. This leads to effective management of the money and increases the chances of avoiding a Margin Call.
Avoiding leverage, if at all possible, is a great way of avoiding a Margin Call. Even maintaining the margin use towards the lower end of the borrowing limit can help as it allows the trader the luxury of having sufficient leverage available for use in tricky or risky market situations.
There are some other ways of mitigating losses and avoiding a Margin Call. However, the ones mentioned above can definitely improve your chances of avoiding one such call from your broker.