What is a Margin Call?

A margin call is an alert sent to a trader to notify them that the capital in their account has fallen below the minimum amount needed to keep a position open. Essentially, it is a signal that the trader must either put up additional funds to balance the account or close positions to reduce the maintenance margin required. If the trader fails to act on this alert, their positions may be closed automatically by their broker to prevent further losses.

What Does ‘On Margin Call’ Mean?

The term ‘on margin call’ is used to describe the status of an account when its funds are below the margin requirement. This status indicates that immediate action is required from the trader to either add more funds or adjust their positions. Failure to do so can result in the broker stepping in to close the trader’s positions, thereby realizing any losses that have accrued.

How Do Margin Calls Work with Leveraged Products?

When trading with leveraged products, such as Contracts for Difference (CFDs), there are two types of margin to consider:

• Deposit Margin: This is the initial amount needed to open a position.
• Maintenance Margin: This is the amount required to keep the position open.

A margin call is triggered when the funds in your account fall below the maintenance margin. For example, if you open a position with a deposit margin but the trade starts to incur losses, the remaining funds in your account may no longer be sufficient to meet the maintenance margin. In this case, your broker will issue a margin call, asking you to top up your account to meet the required margin. If you do not add funds, your broker may close your position to limit further losses.

Why Do Margin Calls Occur?

Margin calls occur primarily due to adverse market movements that result in significant losses in your trading positions. For instance, if you have a leveraged position in a currency pair and the market moves against you, the losses can quickly erode your account balance. This is particularly risky in volatile markets where price swings can be sudden and severe. To prevent your account from going into a negative balance, brokers use margin calls as a safety mechanism.

How Do Modern Margin Calls Work?

The term “margin call” originated from the practice of brokers calling their clients to inform them of an account deficit. However, in today’s digital age, most margin calls are delivered via email or through trading platform notifications. This ensures that traders are promptly informed and can take immediate action to rectify their account balance.

What Should You Do When You Receive a Margin Call?

Receiving a margin call can be a stressful experience, but it is crucial to act promptly and decisively. Here are the steps you should consider:

• Review Your Account: Check your account balance and open positions to understand the extent of the deficit.
• Add Funds: If possible, deposit additional funds into your account to meet the margin requirement and keep your positions open.
• Close Positions: If adding funds is not an option, consider closing some or all of your positions to reduce the margin requirement.
• Reassess Your Strategy: Use this opportunity to review your trading strategy and risk management practices to prevent future margin calls.

Can You Avoid Margin Calls?

While it is impossible to eliminate the risk of margin calls entirely, several strategies can help you minimize their occurrence:

• Use Stop-Loss Orders: Set stop-loss orders to limit potential losses on your trades.
• Monitor Your Positions: Regularly check your account balance and open positions to stay ahead of potential deficits.
• Trade Conservatively: Avoid over-leveraging and trade within your means to reduce the risk of significant losses.
• Maintain Adequate Funds: Keep a buffer of extra funds in your account to cover potential margin requirements.

Example of a Margin Call

Let’s say you have a trading account with $10,000 and you decide to open a leveraged position in a stock that requires a deposit margin of $2,000 and a maintenance margin of $1,000. If the stock’s value drops and your position incurs a loss of $9,000, your account balance would be reduced to $1,000. Since the remaining balance is below the maintenance margin of $1,000, your broker will issue a margin call. You will need to either deposit additional funds to bring your account balance back up or close the position to stop further losses.

In conclusion, understanding margin calls is crucial for anyone involved in trading, especially when dealing with leveraged products. By being aware of how margin calls work and taking proactive steps to manage your account, you can minimize the risks and trade more confidently.