What is a Margin Call?
A trading account can grow only if the trader follows specific money management rules as it is not possible to win one hundred percent of the times. There is no holy grail in Forex trading or magical recipe to make money. The only thing that Forex trading virtually guarantees is that with hard work and discipline profiting from it is possible.
Psychology Matters Most
The way to start Forex trading is straightforward and a trader is supposed to do the following:
- First thing first, to find a good broker. The article dedicated to how to choose the right Forex broker here on our Forex Trading Academy shows the things to watch for and offer a nice guide for finding the perfect broker.
- The next thing to do is to open a demo account with that broker and practice. Trading on a demo account is indicated as it offers a glimpse regarding what the broker is doing with the spreads when the market is volatile and how the overall execution and trading work with that broker. It should be mentioned here that demo trading is tricky as demo trading platforms are not reflecting 100% the real trading environment.
- After trading for a while on a demo account, a live one should be opened with the same broker and trading for real can start.
However, the steps above are not followed by traders even though there are three simple things to do. The reason for that is human nature as psychology plays an important role when trading financial markets. The desire to make a profit is so strong that the basic safety rules tend to be forgotten or ignored. What happens next? The broker gives you a margin call.
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The Inevitable Margin Call
For every trade taken in a trading account, the broker blocks a corresponding margin needed to keep the trade floating. By the time the trade hits the stop loss or the take profit or it is simply being closed, the margin is released and the process starts all over again. Having multiple open positions and with the market going against them, the natural tendency is to add to those losing positions and this way the margin becomes so scarce in the trading account that even a small push further in prices will get you out of the game. However, this is not happening without a notice as by the time the margin level drops below 100%, the broker will start notifying you per email that the margin in the trading account is no longer enough to sustain the open positions and instructs you to either add more funds to the trading account or start closing the positions in order to free margin.
If none of the steps above are followed, the broker will start automatically closing the trades and if the market still goes against the open positions the trader will end up with the trading account being wiped out. This is what a margin call is and what it does to a trading account. The thing is that a margin call is really healthy from a psychological point of view as long as it is not happening often. The trader is being brought to reality and now starts to realize that ignoring those three steps mentioned at the start of this article was a fatal mistake.
Learning from Earlier Mistakes
Receiving a margin call can be a great opportunity to ask the following question: is trading suitable for me or do I have what it takes to trade profitably? Only from this moment of time trading is taken seriously and people will start investigating some more about what to do to trade profitably. There’s no shame in admitting defeat or failure as long as one is learning from it. This is why I mentioned at the start of the article that people fail to follow those simple three steps. Human nature is such as we rather learn from mistakes than following a simple path to success.
How to Avoid a Margin Call?
A simple answer to this question is to simply have a lot of funds in a trading account and constantly adding more than the open positions. Unfortunately, while this is certainly correct, it is not realistic. The idea behind Forex trading and trading, in general, is to grow an account in such a way that in the end trading for a living becomes a reality. A sound money management plan is the cornerstone in avoiding a margin call. One can lose money in a trading account but the broker will not give you a margin call anymore if money management or risk management is correctly applied. There are many money management techniques to be applied and here on our Forex Trading Academy, we’re going to cover them later. At this moment of time let’s just say that risking only a small percentage on each trade is a simple way to avoid getting in trouble again. Perhaps the simplest thing that people do not follow is to set a stop loss on the open trades. Markets can be so violent that without a stop loss a margin call can come in a blink of an eye. As a matter of fact, sometimes not even a stop loss can’t help. The example that comes to mind is the SNB (Swiss National Bank) dropping the 1.20 floor on the EURCHF cross as many traders were on the long side with stop losses just below 1.20. Those stops could not protect the account from being wiped out as by the time the SNB dropped the peg there was no market for thousands of pips and by the time it was a market and the broker closed the trades, the account was wiped out. Not only that the traders lost the money in the trading account, but brokers called for getting also the difference between the actual level the trades were closed and the initial stop loss level.
Trading is a serious business and a risky one and if one is to survive and make a living out of it, risk management is a must. Knowing what a margin all certainly help, but knowing how to avoid it helps more.
Other educational materials
- Setting Up a Chart in Metatrader 4
- Forex Trading Accounts and the Value of a Pip
- The Importance of Swap and Spreads
- How to Enter/Exit a Trade
- How Do I Make a Profit from Forex Trading?
- Forex Market Terminology
Recommended further readings
- “Extreme price movements and margin levels in futures markets.” Edwards, Franklin R., and Salih N. Neftci. Journal of Futures Markets 8, no. 6 (1988): 639-655.
- “Margin call stock loans.” Ekström, E. R. I. K., and Henrik Wanntorp. Unpublished Results (2008).