How to Avoid a Margin Call

Few things can fuzz a trader's heart like a margin call. It is that dreaded notification from your broker: your account is below the required levels, and unless you act now, your positions could be liquidated. For many traders, receiving a margin call feels like the end of the trading road. But the good news is, margin calls can be avoided altogether.

If you have the right mindset about risk, a plan, and discipline, you can prevent marginal calls altogether. The following article will show you how to wisely manage your margins so you can take care of your capital and trade with confidence. 

What Is a Margin Call?

A margin call occurs when your trading account does not have enough equity to remain in your open positions. In simple terms, your broker is saying to you: "Your margin balance is too low for the trades you are holding." If you are unable to add to your margin or close your positions, your broker may liquidate your positions to cover the potential loss from your margin account.

Why do margin calls occur?

A margin call typically happens because of:

•  Over-leverage: Absolute/debt levels too high about your balance. 

•  High volatility: A sudden and recent move against your position.

•  Poor risk management: Not using stop-losses and risking too much per trade.

•  Ignored account balance: Not sufficiently checking your equity/free margin background.

Learning the causes of margin calls is the first step to learning to avoid them. 

The trouble with Over-Leverage

While leverage can increase your profits, it can also increase. New traders are often attracted to high leverage because it allows them to control prominent positions with small amounts of capital. However, the downside is that small market movements can quickly erode a large portion of your account value.

Using low leverage that is proportional to your risk appetite is one of the best ways to avoid margin calls.

The Benefits of Stop-Loss Orders

One of the easiest avenues for avoiding a margin call is the stop-loss order. A stop-loss order closes your trade automatically when the market moves too far against you.

Stop-loss orders serve to protect your capital by limiting your potential loss and freeing you from monitoring every tick. Traders who have no stop-loss orders tend to find themselves in margin call territory much quicker than expected.

Position Sizing is Important

Another critical factor in avoiding margin calls is proper position sizing. Entering trades that are too large for your account is like walking a tightrope without a safety line. It is recommended to risk only a small portion of your capital—1-2% is often a good guide concerning each trade—so that even a larger losing streak will not severely impact your account or put you in margin call territory.

Keep an Eye on Your Margin Level

Monitoring your margin level consistently is a great way to maintain control. Most trading platforms provide a margin level calculated as a percentage, which tells how much free margin is left versus total used margin.

If your margin level is close to 100%, you are at risk of a margin call. By monitoring this regularly, you will be able to scale back position size, close out losing trades early, or add funds to your account before it is too late.

Diversify Your Trades

Putting all of your capital into one trade or multiple highly correlated trades will increase the risk exposure. Diversification, or spreading your positions over several assets or pairs, will lessen the likelihood that one movement in the market would threaten your entire account. You will see that a less diversified portfolio is naturally less likely to experience a margin call!

Don't Trade on Extreme Volatility

Economic announcements, interest decisions, or sudden geopolitical disturbances can create sudden spikes in volatility. Entering the market when it is volatile without preparations could result in losing trades and, obviously, a margin call. If choosing to trade in volatile market conditions, reduce the leverage and/or tighten your position size, and always use a protective stop if available.

Don't Trade with Emotions

Fear and greed are two of the most significant forces driving margin calls! Fear can cause you to run for the exit signs too late, and greed can cause the trader to use excessive leverage and lose their focused plan on how to take excess profits.

Good traders get back to their plans and rules instead of getting lost in their emotions. Keeping emotions in check will reduce the likelihood of making an impulsive decision that could deplete your trading account.

Working the Plan

A margin call is often a product of rain in a spontaneous, unplanned trade! A well-designed trading plan will define when to enter, when to exit, how much money to risk, and how to manage your trades if the trade goes against you.

Trading using a well-designed plan will mitigate risk, as you will be focused and not have to climb above reasonable behavior and take trades that could potentially lead you to a margin call.

Make Strong Risk Management Habits

To summarize, the key to avoiding a margin call is habit, not luck! Good traders do the following:

• Maintain low, reasonable leverage

• They always use stop-loss orders

• They are careful about how they size their position, based on their equity, and potential trade risk

• They are accountable and monitor their account daily

• They avoid trading on unpredictable events without an understanding and preparation for those events

• They are disciplined and stick to their trading plan

These habits can lead to consistency and capital conservation in the long run.

Conclusion

Margin calls can be one of the scariest parts of trading, but they most definitely are manageable. By understanding why margin calls occur and following sound risk management practices, you can make your trading experience less stressful. You can trade more confidently, without worrying about getting a margin call.

Keep in mind, your ultimate goal isn't just to make a lot of money, but also to properly manage your capital and be in the game.

Good traders that survive bad traders do not avoid margin calls altogether; they manage risk so well that they do not let a loss become a margin call! Avoiding a margin call is all about being prepared, disciplined, and keeping your focus on long-term growth and financial stability!