The dreaded margin call… what is it and how does it work. Well, first of all, a margin call is the worst possible scenario. It means that everything went South and your positions were liquidated.
A margin call is a notification to a trader that they must deposit more funds into their account to meet the minimum equity requirements. Based on the amount of leverage taken and the current price movement, margin calls are essentially a trader’s worst nightmare.
Let’s show you an example, where we’ll track your account metrics as we go…
You’ve opened a trading account with $10,000 of your own money. As a result, you’ll see that your Balance, Equity, and Usable Margin are all $10,000.
Since you have not yet placed a trade, your Used Margin sits at $0. Usable Margin is always equal to Equity minus Used Margin.
Usable Margin = Equity – Used Margin
Thus, Equity — and not Balance — determines Usable Margin and if you reach a Margin Call.
If your Equity is greater than your Used Margin, there will be no Margin Call.
Equity > Used Margin = No Margin Call
When your Equity falls below Used Margin, you’re facing the dreaded Margin Call.
Equity < Used Margin = Margin Call
Let’s suppose you’re trading with a margin requirement of 1% — or 100:1 leverage. You buy one lot of GBPUSD.
Equity remains at $10,000. Used Margin is now $100 since the margin requirement on a lot is $100 per lot. And now the Usable Margin is $9,900.
If you were to close that trade at the same price. Everything would go back to where it was before the trade.
But, instead, you decide that you’re confident in that position and buy 89 more lots of GBPUSD for a total of 90 lots (not advised). Your Equity remains the same, but the Used Margin will be $9,000 (90 lots at $100 margin per lot) and your Usable Margin is now only $1,000.
With this extremely large position, you stand to make healthy profits if the trade goes your way. But if it doesn’t, the result will be horrific.
Let’s see how…
GBPUSD starts to drop and since you’re long 90 lots, your Equity will drop along with it. Your Used Margin remains at $9,000 and once your Equity falls below $9,000, your account will have a Margin Call. Some or all of your position will be closed at a huge loss.
And this Margin Call will happen if your position moves only 11.1 pips/units against you. Since each pip in a mini-lot is worth $1 and you opened 90 lots, the pip value is $90.
Thus, if GBPUSD rises 1 pip, your Equity increases by $90. If GBPUSD falls 1 pip, your Equity decreases by $90.
Effective management of margin accounts is essential for any trader who takes on significant risk. Avoiding or mitigating the consequences of a margin call can be done by understanding the context of your account, ensuring you have sufficient capital, and having appropriate stop or limit losses in place. The reality of margin trading is that risks should be taken with great care, as the potential to take large losses is greater than with cash accounts.
If leverage does become too high, ensure that you have additional funds available and adjust leverage appropriately. Taking all these steps can help traders avoid any unpleasant surprises when it comes to margin calls.
Disclaimer: All information provided here is intended solely for study purposes related to trading financial markets and does not serve in any way as a specific investment recommendation, business recommendation, investment opportunity, analysis, or similar general recommendation regarding the trading of investment instruments. The content, in its entirety or parts, is the sole opinion of SurgeTrader and is intended for educational purposes only. The historical results and/or track record does not imply that the same progress is replicable and does not guarantee profits or future profitable trading records or any promises whatsoever. Trading in financial markets is a high-risk activity and it is advised not to risk more than one can afford to lose.