Jun 29 2020 1
The margin call definition can be said to be very important because it relates to the way traders manage capital. However, to understand the definition of margin call, we need to understand some terms relating to margin trading. These terms will be closely related and form the basis for generating a Margin Call.
Put simply, Equity is the balance in the investor's trading account, including the added profit or minus the current losses.
For example: When you deposit $1000 into your account to start trading, your equity then is $1000. If after a while, you make $500, your equity now is $1500. And after that, if you lose $200 in trading, your equity will then become $1300.
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Margin is the amount of money a trader deposits on the broker on each of his trades. Depending on the high or low leverage, the deposit amount will vary.
On each trading order, you need a margin deposit. With many trading orders, you have to deposit many times and the total of the deposit you deposit will be called Used Margin.
Free Margin is the amount of money left in your account after it has been used to deposit.
Free Margin = Equity – Used Margin
Margin Level is a measure of account resistance, calculated as the ratio of the amount of capital in your account to the used margin, in units of%.
Margin Level = (Equity / Used Margin) * 100%
Margin Level is also a concept that many traders confuse in calculating most, including experienced traders.
Let’s take an example:
- You deposit $1000 into your account. Your equity now is $1000
- You open 5 positions and put $20 in each, so your used margin is 5 * $20 = $100
- Now, you free margin is $1000 – $100 = $900
- Therefore, we can calculate your margin level: ($1000 / $100) * 100% = 1000%
Margin call definition
After setting up your trading orders, you unfortunately find the prices going against your prediction, so your equity is decreasing. When Equity is on a par with Used Margin, you don't have the capital to open any more positions and that’s when the Margin Call appears.
Normally, brokers will give your account a Margin Level (usually 30%). If the Margin Level drops below this level, your trading account will be alerted. The notification appearing on your screen is called a Margin Call.
Margin call is something a trader never wants to see. It indicates that your account doesn’t have any money left and you either have to deposit more money into it or you just close the trade and accept the loss.
How to avoid margin call
Choose a reasonable leverage
Leverage is a double-edged sword: you can make a profit faster but you can also lose money fast because of it. When using leverage, your Equity and Margin Levels may drop quickly. At that time, being Margin Call is probably only sooner or later.
So you should use low Leverage. Something within 1:50 or 1:100 is enough.
Trade with small volume
You need to clearly stipulate the level of acceptable losses as% of your total Equity. If you trade too large volumes, or stuff a lot of small orders at a loss, then your Used Margin will increase rapidly, and Equity will be inversely proportional, then Margin Call is what will happen sooner or later.
The level of accepting losses of each person is different, some people only accept the risk of 5% of the account, but there are also those who accept more risk, sometimes up to 20% - 30% of the account. But remember that high risks are associated with high profits, but anyhow, management is still better than emotional action, increasing the volume of transactions in an uncontrolled manner.