Margin calls explained
A margin call is not good news. It happens when the amount of equity you hold in your margin account becomes too low to support your trades and other borrowing rights. When that happens you need to bolster your account with new funds to offset possible losses.
You can put in safeguards to prevent a margin call from happening, such as a stop order. A stop order behaves like an insurance policy and they’re very useful, not just for new traders but for experienced investors.
If you don’t top up your margin maintenance when you receive a margin call, you face potential ruin.
Margin close out – what you need to know
Every margin trader has their margin close out level. This is to protect you from losses from any trading position you have. Look for your margin level on your trading platform.
Consider these guiding levels:
- Good cover (more than 100%): If the margin level is more than 100% then you have sufficient cover to keep all your positions open and there is no need to add further funds at the moment
- Not so good (80% – 100%): This might be where your margin level dips under 100% and you get a margin call
- Automatic closure and warning (50% and below): This could be where your margin level slumps under the 80% threshold
- Close out without warning: A sudden market movement affecting your open positions means your maintenance margin suddenly slumps from 80% to 50%
- If a close out happens, your broker will begin closing your positions until your margin account again reaches about 80%.
What else do I need to know?
Remember that the maintenance margin on your account can be changed by a broker at any time. These are usually not ‘human’ decisions as most trading platforms are run on software.
Successful internet trading also relies on the swift execution of any trade. Web connection, software and hardware need to be reliable, and the risk of equipment failures anticipated.
Bear in mind, too, that there might be modest account commissions and interest to be paid. These costs are deducted from any profits.
What’s the worst case scenario?
If a market suddenly moves against you while you have a trade open, you could potentially lose everything you have in your margin account and still owe more.
While your broker will have worked hard to close out all your positions it might not be possible to close them fast enough to stop the losses.
Some of the retail trading platforms have guarantees that, in the event of the broker’s close out failing to limit your losses in your maintenance margin, they will write off any extra debt.
You would only lose the money you had deposited with the broker.
Always check the small print.
What’s the best case scenario?
You trade cautiously, using limit orders rather than market order, or with stop loss orders in place to limit individual losses. You monitor your trades and close loss-making orders quickly and avoid a margin call.
You benefit from the significant gains margin trading can bring, while avoiding potentially magnified losses.