Margin Call: Definition, Cause, And How To Prevent It

Illustration. (Photo: Unsplash)

YOGYAKARTA - The term margin call may often sound tense for stock traders, forex, or derivatives. This condition can occur suddenly when the market moves opposite to the position taken, making your capital or margin no longer enough to hold losses.

This article will discuss the definition of call margins, general causes, and strategies to avoid them completely so that you can keep your position safe.

Margin call is a warning from a broker to a trader when the equity of trading accounts falls below the required margin minimum limit. With another explanation, your capital balance is no longer enough to support an open position.

Quoted from Investopedia, the margin call occurs when the value of the loss (unrealized loss) exceeds the free margin, so that account equity becomes too small to withstand further price fluctuations. Example:

You open the position of shares with a margin of $1,000.

If the equity value drops to $700, while the broker provides a minimum margin requirement of 30%, the system will generate a margin call.

If funds are not immediately added or partially closed, brokers can carry out automatic liquid sell to protect their capital.

Margin calls cannot be separated from three important concepts: margin, leverage, and equity.

The higher leverage, the smaller the margin needed to open a position, but the risk of margin calls is also getting bigger because small movements in the market will directly affect the equity of your account.

There are several reasons why a margin call can occur, and everything is related to risk management that is less disciplined, among others:

Opening many positions at once without a margin calculation can make free margins run out quickly, especially when all positions move in opposite directions.

Using large leverage is indeed tempting because it can increase the potential for profit, but also the risk of losses will be even greater. Even small price movements can immediately erode your capital.

Without stopping losses, losses will continue to swell. Thus, the margin will be used even bigger until finally brokers send a margin call warning.

Many traders experience euphoria after receiving profits and start opening up bigger positions than usual without considering risks. This often triggers the next margin call.

The sharp movement caused by the release of economic data or sudden news can make the price gap, so that it immediately cuts account equity without having time to close the position.

Each broker has different rules, but the basic principles are the same:

Margin call occurs when Equity margins are minimal.

General formulas: Margin Level fire) = (Equity / Used Margin)\times 100

Example:

Equity: $500

Used Margin: $400

Margin Level = (500/400) \times 100 = 125%

If a broker determines the margin call at 100%, when the margin level touches that number, a margin call warning will appear.

If it continues to drop to 50% or below, brokers generally perform auto liquidation.

Avoiding margin calls doesn't mean you have to be afraid of trading with leverage. The most important keys are discipline, risk management, and awareness of capital exposure. Here are the strategies that can be done to prevent margin calls:

Avoid using all available margins. Select conservative leverage (for example 1:5 or 1:10) so that there is still room for price volatility.

Make sure each position only takes a small part of the total capital (for example 2'3%). This helps reduce the cumulative risk from several positions at once.

Stop loss is the main bastion. The realistic level benefits according to instrument volatility are not just random numbers.

Don't wait for the margin call notification to appear. Check the margin level and free margin regularly before opening a new position.

Adding a balance when the market moves oppositely can save accounts from forced liquidation. The reserve fund will provide flexibility in dealing with extreme volatility.

It's better not to just focus on one stock or one type of asset. Diversification helps spread risk and reduces the risk of huge losses from just one instrument.

That's a review of the meaning of the call margin. Visit VOI.id to get other interesting information.