Have you ever received a margin call notification, and you weren’t certain about how to effectively handle it to prevent your broker from closing your trading positions?
Such an experience can be quite unsettling.
This notification, a stark reminder of the trading world's inherent unpredictability, shows that financial uncertainty can affect even the most seasoned traders. Let's explore the optimal strategies for avoiding margin calls in this article, so then you know how to navigate this situation if it ever arises.
Understanding margin in trading
Margin trading has gained popularity over the past couple of decades, driven by technological advancements and the availability of regulated and relatively cheap online brokerage services.
This type of trading enables traders to invest more money than their initial account deposits, thanks to loans provided by the brokers they use. Margin trading essentially involves the use of borrowed funds to amplify one's capital in the financial markets (stocks, ETF, currencies, indices, commodities…).
This amplification magnifies the impact of both upward and downward market movements on trading performance, leading to increased potential profits or losses.
To engage in margin trading, traders must meet the initial margin requirements. These requirements represent the minimum amount of funds that must be maintained in a margin account to participate in margin trading.
Usually calculated as a percentage of the total trade value, the initial margin serves as collateral, serving to protect the account against potential losses and ensuring traders have a financial cushion to mitigate the risks associated with leveraged trading.
The specific initial margin requirement can vary, contingent upon factors such as the broker's policies, the type of security being traded, the base currency of the account in comparison to the currency of the investments, and the current trading conditions, among other criteria.
Once traders have opened margin positions, they also need to adhere to maintenance margin requirements, which specify the minimum amount of funds that must remain in a margin account after a trade is initiated to retain the open positions. This type of margin can vary depending on the level of risk associated with market conditions, such as volatility and liquidity, for instance.
What can trigger a margin call?
Margin trading offers seasoned traders the potential for lucrative opportunities, provided they have meticulously designed profitable trading strategies with sound money and risk management rules.
However, it also introduces inherent risks, due to the possibility of substantial losses from adverse market movements and leverage working against you.
In addition to the initial margin requirement, which is a prerequisite for opening margin positions, traders must maintain an awareness of maintenance margin requirements and understand the concept of “available margin”.
“Available margin”, a pivotal metric, is derived by subtracting the used margin—money serving as collateral for open positions—from a trader's equity. This value reflects the capital that remains accessible for initiating new trades, or as a buffer against potential losses.
But how do margin calls fit into this framework?
A margin call comes into play when a trader's equity falls below the maintenance margin requirement, often resulting from losses incurred in open positions or rapid shifts in market conditions.
This notification can manifest itself to traders in various ways, depending on the broker and the trading platform they use. Email alerts, pop-up messages, text messages, phone calls or push-up notifications on the trading platform are some of the most common ways for traders to be made aware of a margin call.
In response to a margin call, traders typically find themselves under the obligation to inject additional funds into their trading accounts, with the aim of restoring their equity to, or ideally surpassing, the maintenance margin level, if they want to keep their positions open. But they can also decide to close their positions.
Neglecting a margin call can have severe consequences for traders’ accounts and positions, as it can lead to the enforced liquidation of positions, executed by the broker's back-office, to offset the incurred losses.
Best practices to avoid margin calls in your trading
Here are a few tips about how you can better manage your margins to avoid margin calls:
● Understand what leveraged and margin trading is.
● Adapt the level of leverage to your knowledge and trading experience
● Learn about the different types of margins.
● Learn how margin calls work and how you are aware of them when such situations occur.
● Be aware of margin requirements from your broker for the different types of financial asset classes you’re interested in.
● Use your broker tools to calculate margin requirements when you’re planning to open trades (margin calculator) or to monitor your margin levels (alerts).
● Always have free cash in your trading account.
● Diversify your positions.
● Use stop-loss and take-profit orders
● Adapt the size of your positions to overall market conditions.
● Keep an eye on the economic calendar to be prepared for higher volatility when significant economic releases are published.
● Always monitor your positions, especially if you’re trading over the short-term (scalping, day trading, swing trading).
● Know in advance what you’ll do in case a margin call happens: deposit more funds or close your winning/losing positions.
● Keep additional financial resources available in case you need to add funds to your account.
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