The stop-out level is a term that many people have looked at before and wonder what exactly it is. Unfortunately, there is no good news coming your way when you learn about what this term really means. It is a frightening term that is even scarier than the margin call term, though the two are similar. Let’s put it this way: A stop-out level is not something that you want to see on your account at any time. We will get into why that is the case.
Margin Level Falls Too Low
Your stop-out level is triggered when your margin level falls too low to keep any or all of your trades open. This means that you are overextended as far as your margin requirements are considered, and the currency pair that you have traded is now at such a level that the broker has no choice but to liquidate your position at a loss to you. They will trigger the liquidation process, and you simply have to accept that there is nothing more that you can do at this point. You just have to take the hit to your account and vow that you will never again let yourself hit such levels.
The Liquidation Event
Most brokers offer their traders some kind of warning system before the trade reaches a point where it hits a stop-out level. Different brokers have different standards, but many will warn their trade that a stop-out is a real possibility at least 10-20% above the level where a stop-out becomes inevitable. This gives the trader the chance to add more funds to their account to avoid a stop-out, or to decide to close out the position themselves before it drops in value any further.
Sometimes, market conditions are so violent that the broker doesn’t have a real chance to warn the trader that a stop-loss is going to happen. They may have no option but to liquidate the position if the volatility has put them in a position where the currency rises or drops very rapidly.
The liquidation will be automatically triggered, and the broker will likely notify the trader that this has happened. You could get a very scary e-mail from your broker that your position has been liquidated to cover the margin requirements for the trade. It is upsetting to see that e-mail come across, but that is what happens when stop-out levels are reached.
When It Hits Your Required Margin
The important thing to remember about a stop-loss level is that it will only be reached when your floating loss hits up against your required margin for the position. If you have a $1,000 account with one trade open that requires $200 in used margin to remain open, then your trade would need to sustain an $800 floating loss to trigger the stop-out level that would cause the position to be liquidated. That would be a pretty extreme loss on one position, but it can happen. Things can get even hairier when you have multiple positions open or when you trade in bigger lot sizes that require more used margin to remain open.
Let’s imagine that you decided you were a big shot and knew where the EUR/USD was going to trade. You open a position for 40,000 units worth of the currency and are bullish on its prospects, so you submit a buy order. Now, you have approximately $800 worth of used margin, and just $200 worth of free capital (on your $1,000 account). The only problem is that each pip that the currency moves gains or costs you approximately $4. Do you see the problem here?
A 50-pip movement against you means that you are down $200 and hitting up against your $800 in used margin. Your account could hit a stop-out level, and your position might be liquidated at that point. Thus, you would have the $200 loss locked in on the spot, and you would have no option but to either accept the liquidation event or deposit more money into your account to prevent it from happening. You would surely be kicking yourself at that point wondering why you ever invested so big on a single trade with a small account.
What Happens If You Have Multiple Positions Open?
If you are a small account and are trading in multiple positions, then you are really playing with fire. You might have several of your positions all hit stop-out levels at once, or you could have a single position drag your entire account into a stop-out level. Whatever the case may be, you could definitely hit a stop-out liquidation event much more quickly if you are dealing with multiple positions being opened all at once. It is best in your early days as a Forex trader to try to limit your exposure to risky plays like this. Why not limit your risk of being liquidated by just keeping a single position open and only investing a small amount in that trade? You want to keep your free capital open if possible, and the only way to make that viable is to trade small and only on one trade at a time.
If you are successful and manage to build your account up over time, then you might consider opening it to the possibility of additional trades and larger positions at that time. Until then, you will want to avoid the disasters described above and keep your trading strategies simple. The less risk you take, the better your account will fare for you overall.
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.