In our previous articles, we looked in detail at margin and leverage. We saw that when trading forex or other CFD’s (Contracts for Difference) on margin we were required to have an amount of money (initial margin) available in our account to open a leveraged position. This amount of money needed to open the position is a fraction or percentage of the value of the underlying contract value.
We saw that the ratio between the trading account’s equity and margin was expressed as a percentage in the MT4 trading platform as margin level and that the margin level can be used to gauge the ‘health’ of the trading account. A recap on margin level is available here.
What happens if the margin level reaches 100%?
If the margin level reaches 100%, the amount of funds in the account are running low and no new trades can be opened.
If the margin level falls further and reaches 80%, this triggers a margin call as a warning to alert the investor they are close to losing all their capital. If no action is taken and the margin level continues to drop further, at a margin level of 50% a Stop Out will be initiated.
Close up look at the Stop Out
A stop out is the process of automatically liquidating open trades. Because we want to protect your investment, we use a stop out to prevent you from going into a negative balance. If the margin level displayed on the MT4 platform reaches 50%, then the system will automatically start closing trades from the least profitable one.
Let’s have look at the following example to see how this works:
An Investor has a trading account with a balance of 10,000 USD, they open a trade that requires a margin of 1,000 USD. Click here to access our margin calculator.
Assuming the trade moves against them resulting in an unrealised loss of -9,000 USD, their Equity will now be 1,000 USD.
Now that we know the used Margin and Equity of the account we can calculate the Margin Level using the formula:
Margin Level is: (Equity/Margin) x 100.
Equity = 1,000 USD
Margin = 1,000 USD
So, the Margin Level = (1,000/1,000) x 100 = 100%
If the trade continued to move against them by an additional -200 USD, their unrealised loss would now be -9,200 USD leaving an Equity of 800 USD, the margin level would now be as follows:
Equity = 800 USD
Margin = 1000 USD
Margin Level = (800/1,000) x 100 = 80%
Because the Margin Level has now reached 80%, a Margin Call is triggered in the trading platform to alert the investor that they are close to losing all their Capital. At that point they can:
• Take no action
• Top-up the account
• Close some of the open positions, to free more capital
Assuming that no action was taken and the position continues to move against them by another -300 USD their unrealised loss would now be -9,500 USD leaving an Equity of 500 USD, the margin level would now be as follows:
Equity = 500 USD
Margin = 1000 USD
Margin Level = (500/1,000) x 100 = 50%
With the Margin Level now at 50%, the account would trigger the stop out and to protect the investors account the open positions will be automatically liquidated starting with the least profitable trade first.
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