Trading on margin allows traders with minimal capital to generate large profits (or losses).
If you don’t understand the concept of margin or don’t know what to do when your broker issues a margin call, your trading account will most likely collapse.
Here are five strategies for avoiding a margin call.
1. Know what a Margin Call is
Understanding what a margin call is and how it works is the first step toward avoiding one.
Most inexperienced traders want to concentrate on other aspects of trading, such as technical indicators or chart patterns, but they pay little attention to other critical variables such as margin requirements, equity, used margin, free margin, and margin levels.
If you get a margin call out of nowhere, it usually suggests you have no idea what caused it and are opening transactions without considering margin requirements. If this describes you, you will fail as a trader. Guaranteed.
A margin call occurs when the Margin Level in your account falls below the statutory minimum level.
At this time, your broker will alert you and request that you deposit additional funds into your account in order to meet the minimum margin requirements.
Because this process is now automated, your broker will most likely tell you via email or text rather than a phone call.
2. Even before you place ANY order, you should be aware of the Margin Requirements.
It is critical to understand the margin requirements BEFORE you open a trade. Most traders don’t give margin calls much thought, especially when they place pending orders with their broker.
Traders often place an order with their broker, which remains open until the limit price is met or the pending order expires.
When you place a pending order, your trading account is not affected because pending orders are not subject to margin.
However, you run the danger of the pending order being filled automatically. If you are not carefully monitoring your margin level, this order may result in a margin call when it is filled.
To avoid this, you should think about margin requirements before placing an order.
You must account for the margin amount that will be removed from your free margin, as well as an extra margin to provide your deal some breathing room. It’s easy to become confused when you have many pending orders open, and if you’re not careful, these orders could result in a margin call. To avoid such a disaster, you must first grasp the margin requirements for each position you intend to enter.
3. To avoid margin calls, use stop loss orders or trailing stops.
If you don’t understand what a stop loss order is, you’re setting yourself up to lose a lot of money.
A stop loss order, on the other hand, is essentially a stop order sent to the broker as a pending order. When the price goes against your transaction, this order is triggered. For example, suppose you were long 1 mini lot of USD/JPY at 110.50 with a stop loss of 109.50.
This indicates that if USD/JPY falls to 109.50, your stop order will be activated and your long position will be closed for a loss of 100 pips or $100.
If you traded WITHOUT a stop loss order and the USD/JPY continued to fall, depending on how much money you had in your account, you would eventually trigger a margin call.
A stop loss or trailing stop order protects you from further losses, allowing you to avoid a margin call.
4. Scale in positions rather than entering all at once.
Another reason some traders receive a margin call is because they overestimate price change.
For example, you believe that the GBP/USD has risen much too quickly and far too far, and you believe that the price cannot rise any further, so you create a massive short position.
This form of overconfidence raises the likelihood of triggering a margin call.
One strategy for avoiding this is to construct a trade position, often known as “scaling in.” Instead of trading with four micro lots right away, start with one. Then, when the price moves in your favor, add to or “scale in” to the position.
While entering new positions, you can begin increasing the stop losses on earlier positions to minimize possible losses or even lock in profits.
When you combine all of your holdings, you may maximize your gains while trading risk-free. While this normally implies allocating more capital to the bigger margin need, scaling in positions at multiple price levels and employing different stop loss levels spreads out your risk of losses on the transaction, lowering the likelihood of a margin call (when compared to opening one big position size all at once).
5. Know what YOU are doing as a Trader
It’s not uncommon to hear about noob traders who are hit with a margin call and don’t know what the hell happened.
These traders are the types of traders who are just focused on how much money they can make and don’t know what the hell they are doing and don’t fully understand the risks of trading.
Don’t be that trader.
Risk management should be your main priority, not profits.
Next Lesson: How to Choose a Forex Broker
