The Margin Call and the Stop Out are tools offered by any worthy broker. However, apparently limiting for the trader, they are instead a tool of guarantee, a kind of life guard able to prevent real economic damage. The basic concepts are not hard to understand, despite their application involves some complex elements. In addition, in order to fully understand the meaning of Margin Call and Stop Out it is necessary to know other concepts, such as the Equity and the Margin.
What are the Margin Call and the Stop Out
Fundamentally, both the Margin Call and the Stop Out are tools that prevent the occurrence of unsustainable losses and damage to the trader. They are tools of guarantee and prevention. In particular, they prevent the account from going in the red, producing higher losses than the deposit.
From the semantic point of view, the Margin Call is the operation with which the broker “warns” the trader that their account could go in the red and that the trade currently open has suffered significant losses. When the trader makes the Margin Call, they strongly advise the broker to close the position, even if in loss. The purpose is to avoid further losses, therefore preventing the worst.
The Margin Call is activated in certain conditions. Such conditions are fixed a priority by the broker and are generally made public, so that the trader can know them before opening the account. In any case, the conditions in which the brokers makes a Margin Call are the attainment of a certain value, result of the ratio – expressed in percentage – between Equity and Margin. Therefore, in order to understand the real meaning of the Margin Call, it is necessary to know about the concepts of Equity and Margin.
The definition of the Stop Out is similar. Nevertheless, its effects are different from those of the Margin Call. Also the conditions that trigger it are different, but only quantitatively.
If with the Margin Call the broker warns and orders the trader to close the positions since they have suffered too high losses, with the Stop Out the broker automatically closes the positions, since the losses have already reached the maximum tolerance level. Therefore, the Stop Out works as a Stop Loss, but the exit is made directly by the broker following a much more serious loss. Also in this case, in order to fully understand the meaning of Stop Out it is necessary to know the definition of Equity and Margin. We will discuss them in the next paragraph.
First, we should consider the importance of Margin Call and Stop Out. Are these tools really necessary? Absolutely yes, also because in trading the possibility to go in the red is not at all theoretical. Actually, when operating in leverage, such possibility is concrete.
In fact, those who operate in leverage, generate profits that go beyond what is really invested. If a trader opens an order of 1,000 euros and uses a leverage of 1:100, it is as if they were investing 100,000 euros. A 1% profit therefore will not correspond to 10 euros, but 1,000 euros. This is obviously also valid for the losses. This is where the greatest danger lies: generating losses that are higher than the account balance.
The Margin Call and the Stop Out are therefore necessary to avoid the classic reds in the leverage operations, a dramatic occurrence for the trader and, in reality, also quite uncomfortable for the broker. These protect the broker and the trader at the same time.
What are the Equity and the Margin
The Equity and the Margin are necessary to explain the mechanism at the basis of the Margin Call and the Stop Out. The reason is simple: the level at which these two tools activate is given by the ratio between Equity and Margin. Such level is called Margin Level.
The formula of the Margin Level is apparently very simple: Equity / Margin x 100.
The equity is the value of the position. Such value has a starting point but obviously changes based on the outcomes of the position itself. If for example the position is long, but the asset depreciates, the value of the equity decreases.
The concept of Margin is very complicated and involves exclusively the operations in leverage. The formula is the following: value of the asset at the opening x value of the lot / leverage.
Now, the Margin Level beyond which the Margin Call and the Stop Out are triggered is decided autonomously by the broker. This value can actually be considered as one of the many criteria through which the trader choses a broker rather than another. The degree of caution of the broker comes from the policy of the margin.
Obviously, the Margin Level related to the Margin Call is higher than that related to the Stop Out. After all, the first is similar to a yellow light, therefore a warning; the second represents a red light, therefore imposes a forced exit. It goes without saying that the context in which the Stop Out occurs is “worse” than the one of the Margin Call.
A practical example
A practical example will help to understand how the Margin Call and the Stop Out work, as well as all the elements connected to them (Equity, Margin etc.).
Let us imagine an operation in leverage on euro-dollar. In particular, the purchase of a mini lot with leverage ratio 1:100 and a real investment of 100 euros.
Assuming an euro-dollaro exchange at 1.32921, the Margin will be: 1.32921 x 10000 / 100 = 132.921 dollars = 100 euros.
Now, let us imagine that the Margin Level of the Margin Call is set on 60% and the Margin Level of the Stop Out is set on 30%.
So, let us imagine that the euro-dollar loses 300 pips and the equity drops to 60 euros. Here is when the Margin Level will go to 60 / 100 * 100 = 60%. The conditions for the Margin Call are met and the trader receives the warning.
Let us imagine instead that the euro-dollar loses 600 pips, and the equity drops to 20 euros. The Margin Level will be 20% and therefore the Stop Out is triggered with the forced closure of the operation.
The proposal of Key To Markets
The proposal of Key To Markets is sensible. Basically, the Margin Level for the Margin Call and the Stop Out are higher than the average. This is not a limit, on the contrary it is a guarantee of safety for those who want to operate in leverage. Thanks to high levels, the trader can use even significative leverages and prevent not only the danger of going in the red, but also the simple risk of losing “too much” capital.
Key To Markets, with its peculiar margin policy, does not only protect itself but also protect the trader. It is in fact aware of the fact that the leverage can be a double-edged sword and therefore requires effective tools of protection.
In particular, the Margin Call of Key To Market is triggered when the Margin Level reaches 120%. The Stop Out is instead triggered when the value reaches 100%.
These values allow Key To Markets to offer even very high leverages, of the order of 1:500. This represents an advantage for the trader, moreover an advantage in the safest context possible.