Trading on margin is a way for traders with limited capital to make significant profits (or losses).
If you fail to understand the concept of margin or not knowing what to do when faced with a margin call from your broker, you will definitely experience the shock of your trading account blow up.
Here are five ways to avoid a margin call.
1. Know WTF a margin call is.
Understanding what margin call is and how it works is the first step in knowing how to avoid one.Most new traders want to focus on other details of trading such as technical indicators or chart patterns, but little thought is given to the other important elements such as margin requirements, equity, used margin, free margin, and margin levels.
If you’re hit with a margin call out of the blue, this usually means you have no clue what causes a margin call and are opening trades without considering margin requirements.
If this is you, you are doomed to fail as a trader. Guaranteed.
A margin call occurs when your account’s Margin Level has fallen below the required minimum level. At this point, your broker will notify you and demand that you deposit more money in your account to meet the minimum margin requirements.
Nowadays, this process is automated so your broker will probably notify you by email or text rather than receiving an actual phone call.
2. Know what the margin requirements are even before you place ANY order.
Knowing the margin requirements BEFORE you open a trade is crucial.The concept of margin call isn’t thought about much by most traders, especially when they are placing pending orders with their broker.
Typically, traders tend to place an order with their broker and it remains open until the limit price is reached or until the pending order expires.
When you place a pending order, your trading account is not affected because margin is not applied to pending orders.
However, this exposes you to the risk of the pending order being automatically filled.If you’re not properly monitoring your margin level, when this order gets filled, it could result in a margin call.
In order to avoid such a situation, you need to consider margin requirements before placing an order.
You have to account for the margin amount that will be deducted from your free margin, as well as having some additional margin so your trade will have some breathing room.
When you have multiple pending orders open, it can get quite confusing and if you’re not careful, these orders could result in a margin call.
To avoid such a tragedy , it’s crucial that you understand the margin requirements for each position you plan to enter.
3. Use stop loss orders or trailing stops to avoid margin calls.
If you don’t know what a stop loss order is, you’re on your way to losing a lot of money.
As a refresher though, a stop loss order is basically a stop order sent to the broker as a pending order. This order is triggered when price moves against your trade.For example, if you were long 1 mini lot on USD/JPY at 110.50, and you set your stop loss at 109.50.
This means that when USD/JPY falls to 109.50, your stop order is triggered and your long position is closed for a loss of 100 pips or $100.
If you traded WITHOUT a stop loss order and USDJPY continued to fall, at some point, depending on how much money you have in your account, you would trigger a margin call.
A stop loss order or a trailing stop order prevents you from taking on further losses, which helps prevent getting a margin call.
4. Scale in positions rather than entering all at once.
Another reason why some traders end up with a margin call is because they misjudge price movement.
For example, you think GBP/USD has gone up way too high and too fast and you believe that there is no way price can go higher, so you open a HUGE short position.
This type of overconfident trading increases the probability of triggering a margin call.
To avoid this, one approach is to build a trade position, also known as “scaling in”.
Instead of trading with 4 mini lots right off the bat, start off with 1 mini lot. Then add or “scale in” to the position as the price moves in your favor.While you continue adding new positions, you can also start moving the stop losses on the previous positions to reduce potential losses or even even lock in profits.
Position scaling can help you magnify your profits while trading risk-free when you combine all the positions.
While this usually means that you’ll have to allocate more capital towards the larger margin requirement, scaling in positions at different price levels and using different stop loss levels means that your risk of losses on the trade are spread out which lowers the probability of a margin call (when compared to opening one big position size all at once).
5. Know WTH 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.