Traders go through exhaustive lengths to keep away from margin calls in forex. Therefore, understanding how margin call materializes is crucial for successful trading.
To gain an understanding of how a margin call works in forex, it is important to be aware of the connected concepts of margin and leverage. Margin and leverage are one of the same. Margin is the minimum requirement of funds needed to make a leveraged trade, while leverage gives traders bigger exposure to markets without having to fund the complete amount of the trade.
Always remember that trading with leverage contains risk and can likely produce huge profits as well as huge losses.
What Causes a Margin Call?
A margin call takes place when a trader no longer has any usable/free margin. In other words, the account requires additional funding. This happens when trading losses take away the usable margin under an acceptable level determined by the broker.
A margin call can potentially take place when traders commit a big amount of equity to the used margin, not leaving enough room to soak up losses.
When a margin call occurs, a trader is closed out of their trades. The trader no longer has sufficient funds in their account to absorb the losing positions and the broker is on the line for their losses, which is also bad for the broker. It is necessary to know that leverage trading in certain situations can cause the trader to owe the broker more than what has been originally deposited.
How to avoid a margin call?
Leverage is usually considered a double edge sword. Meaning that the more leverage a trader uses, the less margin a trader will have to soak up any losses. An over-leveraged trade can go against a trader which will result in the losses depleting their account.
When the available margin percentage drops to zero, a trader will receive a margin call. One way to avoid this would be to use protective stops to reduce potential losses from happening. Another would be for the trader to not over-lever their trading account and engage in effective risk management.