Avoiding a Margin Call in Forex
If there are two words that you never want to hear as a trader, it’s going to be “margin call.” A margin call is when a broker asks that the trader deposits additional money into the account to keep a position or positions open. There is a certain amount of maintenance margin that is necessary to keep a trade open, so if you don’t have that value of cash in your account, you will be forced to liquidate your leveraged position.
Margin is crucial when it comes to Forex, because it is essentially your “deposit” for a larger position. For example, if you have 50 times leverage, for every $1 you deposit into an account, you can control $50. In that example, you could trade $50 worth of currency for a single dollar. That leverage is part of what makes forex so attractive, because you can magnify your gains. However, trading 50 times your deposit also means that your losses get magnified.
Margin is without a doubt a double edge sword, and something that you should be very cautious with. Most professional shops don’t trade with more than 10 times leverage, which is partly compared to what most retail traders use. Having said that, if you are trading a $50 million position, 10 times leverage is much more impressive than with a $1000 position.
Your first job as a trader
Without a doubt, job number one as a trader is to protect your trading capital. If you get wiped out, there are no more trades to be had. This is what we use stop losses for, as it gets us out of the market when we are proven incorrect in our analysis. This is why keeping your margin under control is crucial, because you may not be wrong with your position longer term, but if you are too highly levered, you can be forced to leave the market before the trade has worked itself out.
By taking care of the margin, you give the trade “room to breathe”, and more importantly you give yourself a chance to be successful. You will have losing trades, so placing massive positions on is a great way to lose your money and blow up your account. You must keep in mind that the professional trader constantly worries about protecting their account. If you place intelligent trades and follow a statistically profitable system, the gains of course will come, over time.
You don’t have to use all your leverage
Let’s take an example to show how you could avoid using all of your leverage. If your account has $10,000 in it, and you have 50 times leverage, you have the ability to trade $500,000 worth of currency. In other words, you could short EUR/USD in an increment of $500,000. However, it would only take the slightest of moves to knock you out of the market due to a margin call. After that, you would have whatever’s left in your account sitting as available margin.
But let’s assume that you are much more cautious than that and decide to buy a position that’s worth $25,000. You would need $500 for margin, leaving the ability to lose as much is $9500 before being forced out of the market. It would take much more in the way of a move against you to make that happen.
Beyond that, you obviously wouldn’t let the market move against you in that sense, and therefore if you had a 100 PIP stop loss, with a $25,000 position, you are looking at a loss of $250. After that loss, you still have $9750 left in your account. (This is all before trading costs etc.)
In other words, this gives you the ability to build up your account over time. Unfortunately, that is one of the biggest problems that I ran into with new traders, they don’t have patience. They don’t understand that the world’s largest traders to build up their accounts over time, and not overnight. They unfortunately read a few stories here and there over the last century where people have made massive amounts of money in a short amount of time, but that’s the exception, not the norm. These are obviously filed under the “sales material” label in the sales brochures.
The main take away
The biggest thing you can do is keep your position size reasonable. Unfortunately, far too many people don’t and they end up hurting themselves financially. Trading Forex and other levered markets for that matter is going to be much different than other instruments such as stocks. You are borrowing money to play a larger position. On a percentage basis, currencies simply don’t move enough to warrant trading without some type of leverage. A strong move over the course of the year might be 7% in a currency pair. However, with leverage that becomes a much more interesting proposition.
Unlike stocks, you don’t actually own anything. You are speculating on movement. If you are long FedEx at a specific price, you still own that piece of the company regardless of how much it falls. You are not levered, and therefore you don’t have to worry about margin. Therefore, you should never over lever, or for that matter add to a losing position. Forex can be very profitable, but you need to be intelligent about all of that power you hold.