The existence of stock and money markets over the centuries has led to the formation of a unique vocabulary. Misunderstanding these terms can cause losses for newcomers.
When stocks fall, causing traders stress, the "margin call" enters the scene. This is a requirement to deposit additional funds, which can lead to loss of investment in forex or stock market.
An investor can use not only personal capital, but also borrowed finances from an intermediary. To do this, the trader's account must have a certain amount of money, which acts as a guarantee for the loan - this is a margin guarantee. This money is "frozen" for the period of the operation and serves as collateral.
Leverage and margin trading[]
Leverage is the ratio of a trader's own funds to the borrowed funds provided by a broker for stock exchange transactions. Traders use these borrowed funds to increase their market operations, which is known as margin trading. In stock exchange trading, transactions using broker finances are sometimes referred to as "trading on margin."
Using borrowed funds for stock transactions can significantly increase income. However, it also amplifies potential losses. This material details the dangers associated with working in the stock market.
If market conditions deteriorate and the investor's account loses money, the broker may require additional investments by sending a demand for additional funds - this is known as a margin call.
The investor is notified either via email or directly in the broker's trading interface. It is important to note that the broker does not close positions automatically. However, the trader's actions are limited: prohibition to open new positions and opposite orders. Only three options for further steps are available.
- Deposit additional funds: This may result in either trades closing successfully or significant losses.
- No change: If the stock rises in price, the losses will be leveled off and no money entry will be needed. But if prices fall further, free margin will not be enough.
- Broker leverage: If the account goes to a critical low, the broker will activate a stop out, closing all positions to prevent a total loss of funds, including borrowed funds.
When an investor manages several positions, it is critical to close the ones that bring losses in time, while profitable ones can be kept open. If the situation does not improve, it is time for a margin call.
This threshold and warning about the lack of funds, known as Margin Call, is expressed by the broker as a percentage of the collateral provided by the investor.
A variety of events can cause fluctuations in the financial markets. These include:
- Politics: Changes in the political landscape, such as elections of country leaders, decisions on international cooperation (like Brexit).
- Health: Large-scale health-saving crises, including pandemics like coronavirus.
- Economic data: Statistics related to employment and labor activity.
Differences between Margin Call in Forex and Stock Exchanges[]
Margin Call in the stock market and Forex differs in regulatory mechanisms and implications for traders.
There are differences in the use of Margin Call in Forex and traditional stock exchanges, especially noticeable in the amount of leverage provided. Forex brokers can offer high leverage up to 1:100 and above, which is available for all currency pairs.
In case of serious losses of the trader, reaching 95% of the invested funds, the broker can initiate a stop out process. Each broker has its own criteria for determining the level of risk, which affects the moment of activation of margin call and stop out.
On equity exchanges, leverage is more modest, typically ranging from double to quadruple the investment. Traditionally, when losses reach 50% of the initial amount, trades are stopped.
Forex brokers often overlook margin calls, important for guarding clients against risky moves. There is not even always a warning prescription in the contracts with clients, the rapid reduction of funds in the account and the urgency of action.
In the forex market, investors face the risk of margin calls despite the existence of protective tools. Brokers may apply their own rules that make a margin call equate to a level of forced position closure (stop out). When traders receive such notifications, it often means instantaneous closure of all trading operations.
Experienced market participants emphasize the importance of being aware of the variety of terms and conditions provided by brokerage firms, including rules on margin trading. It is important to choose a broker carefully, paying attention to margin requirements.
Strategy in a falling market[]
Investors should be prepared for the inevitable equity losses during periods of financial crises when panic grips the markets when the market is experiencing significant market turmoil.
Determining the minimum point at which asset values may fall is a task with a high degree of uncertainty. Forecasts in this direction are most often not profitable and carry risks.
A sharp jump in securities prices is a common phenomenon, and even professionals are not immune to losses. However, adherence to risk management strategies helps them minimize potential financial losses and prevent forced closing of positions due to lack of funds in the account.
The main methods of controlling potential losses include:
- Stop-Loss: an order to sell assets is automatically executed when their value falls to a predetermined level, preventing further losses.
- Reduce Quantity: Reducing the volume of trades to control risk.
- Capital growth: Increase investment capital as market volatility increases to spread risk.
- Personal funds: Avoiding margin trading, which can be misleading as to the real position of the account. These strategies help reduce the damage from unexpected price changes in the market.
In addition, there are always some things to keep in mind when trading on the stock exchange:
- Avoiding rollovers: Avoid rolling over open trades to the next day.
- Closing before the news: Fix trading results before the publication of key economic data.
- Caution in the negative: Reduce the volume of trades in the face of unfavorable news by 3-5 times.
- Exceptions: Be aware of possible exceptions to these rules.
- Stop Loss Limitations: Take into account that stop loss may not work in case of gaps, as it was, for example, in the Russian markets on February 24 and March 9, 2020.
During the weekend period, when trading floors remained closed, there was a significant drop in asset values in international markets. The opening of trading on Monday was marked by quotes falling below the levels of many stop orders.
Investing with own funds can lead to a gradual build-up of profits, while sustaining losses is possible even with deleveraging. However, being in a stable state of margin call in the financial market is unattainable.
Investment strategies and conclusions for investors[]
When conducting investment activities, it is extremely important to be able to change the direction of investment in a timely manner in accordance with market conditions. In addition, safety measures, such as stop-losses, must be taken, but their effectiveness is not always guaranteed.
In case of sudden changes in the market, such as the introduction of taxes on deposits and securities, such measures will not prevent losses due to market price gaps. Active portfolio management and constant monitoring of price changes are key to avoiding significant losses, especially in times of economic instability.