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What does Margin Call and Stop-Out depend on?
Every investment comes with risk. The risk itself results from the selected market, the current situation and other variables, but it mainly depends on the investor's actions. Not everyone is born with an excellent knowledge of trading in the financial markets and the degree of preparation of traders varies. Therefore, the brokers have prepared security mechanisms that will prevent the investor from losing all funds or avoid having to repay the debit - Margin Call and Stop-Out, which are often confused with each other (or rather erroneously believed that the former has the functions of the latter).
margin Call
Literally it can be translated as "security call". This was due to the fact that in the previous century, when the Internet was not very popular, most orders were carried out by phone. In all transactional matters between the client and the broker, contact was also made in this way.
When an investor keeps lossy transactions on his account, the minus of which is still deepening, he suddenly reaches such a level that the brokerage house recognizes (usually it is a predetermined level) that it is too risky to continue doing so. In this case, he contacts the customer to pay the deposit as soon as possible and to increase the collateral for the transactions being held or otherwise close. Currently, there is no contact with clients on forex platforms and such information is displayed on the platform (in various ways), however, the conditions are the same.
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In the event that the client does not increase the deposit, he will not reduce losses or the market will not turn back, this will be Stop-Out.
Stop-Out
This mechanism is already the final consequence we have led to inefficiently investing. With the loss of the vast majority of ours capital, after a warning in the form of Margin Call, the risk of an overdraft is very high. The broker is therefore forced to close our lossy positions. It can close one of them (usually the most lossy) or immediately all open positions. It often happens that if it closes one transaction, small changes to our disadvantage in other open positions force the re-use of Stop-Out.
How does it look in practice
Both of these mechanisms operate at a certain moment. This moment usually results from a parameter such as Margin Level or the degree of leverage. The very level at which Margin Call and Stop-Out occurs is determined individually by each broker. Usually it is not possible for the customer to change it.
To explain how it works, we have to explain a few basic concepts:
- Equity - account balance taking into account the balance of open positions, i.e. if we have deposited USD 10 into the account and the open transactions currently bring us income of USD 000, our Equity is USD 2150.
- Margin - in other words, a security deposit, i.e. funds that have been blocked on our account due to the opening of a position. The bigger the trading volume, the bigger the margin.
- Margin Level - It is the ratio of Equity to Margin expressed as a percentage, which determines the moment of activation of the above-mentioned protection mechanisms.
Pattern:
Margin Level = Equity / Margin * 100%
Let's assume that Margin Call (MC) is set to 50% and Stop-Out (SO) to 30%.
Example 1
- 1 lever: 100
- Account status 10 000 EUR
- Open 3.0 flights on EUR / USD
- Margin 3 000 EUR used
Equation for MC -> 50% = X / 3 EUR * 000%
It follows that Margin Call will work at the moment when Equity will be 1 500 EUR, that is, with 8 500 EUR the loss on the account. At this moment, the warning lamp will light.
Equation for SO -> 30% = X / 3 EUR * 000%
It follows that Stop-out will work at the moment when Equity will be EUR 900, that is, with 9 100 EUR losses on the account.
READ NECESSARY: Stop-Out mechanism after entering the ESMA guidelines
And with higher leverage?
Example 2
- 1 lever: 500
- Account status 10 000 EUR
- Open 3.0 flights on EUR / USD
- Margin 600 EUR used
Equation for MC -> 50% = X / 600 EUR * 100%
It follows that Margin Call will work at the moment when Equity will be EUR 300, ie with 9 700 EUR losses on the account. At this moment, the warning lamp will light.
Equation for SO -> 30% = X / 600 EUR * 100%
It follows that Stop-out will work at the moment when Equity will be EUR 180, that is, with 9 820 EUR losses on the account.
Summation
As you can see, the speed of the hedging mechanism depends (apart from the account balance, position balance and blocked funds) indirectly on financial leverage. The greater the leverage, the less capital we block in Margina. Thanks to this, Margin Call and Stop-Out will work later but at the same time in a crisis situation the defense mechanism will work later.
However, it should be remembered that the lever itself is not risky. In fact, we decide what position and volume we will open when we close it and whether we will use the Stop Loss orders.
