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Level-1 Module-6 Chapter-11
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In the world of trading, understanding margin requirements and their implications can make or break your investment strategy. In this article, we’ll dive deep into a specific trading scenario involving a Margin Call Level set at 100%, without a separate Stop Out Level. Let’s explore how these conditions affect your trading account, especially during challenging market movements.
What Are Margin Calls?
A margin call occurs when the equity in your trading account falls below the required level due to losses on open positions. For brokers that only operate with a Margin Call and not a Stop Out Level, once the Margin Call Level is reached, the trader must deposit more funds to maintain their position or risk automatic liquidation of their trades.
Step 1: Setting Up Your Trading Account
Let’s assume you’ve just opened a trading account with a balance of $1,000. Your trading account overview would look like this:
Long/Short: Open Position
FX Pair: EUR/USD
Position Size: 1 Mini Lot (10,000 units)
Entry Price: 1.15000
Current Price: 1.15000
Margin Level: 100% (initially)
Equity: $1,000
Used Margin: To be calculated
Free Margin: To be calculated
Balance: $1,000
Floating P/L: $0
Step 2: Calculating Required Margin
You decide to go long on the EUR/USD at an entry price of 1.15000. The broker requires a 2% Margin for this position.
Notional Value Calculation:
Notional Value = 10,000 EUR (mini lot) × 1.15000 = $11,500.
Required Margin Calculation:
Required Margin = Notional Value × Margin Requirement
Required Margin = $11,500 × 2% = $230.
Step 3: Assessing Used Margin
Since you only have one position open, the Used Margin is equal to the Required Margin:
Used Margin: $230.
Step 4: Calculating Equity
Assuming the price is stable, your Equity remains the same:
Equity: Balance - Used Margin + Floating P/L = $1,000 - $230 + $0 = $770.
Step 5: Free Margin Calculation
Free Margin allows you to open new positions. It is calculated as:
Free Margin = Equity - Used Margin = $770 - $230 = $540.
Step 6: Determining Margin Level
The Margin Level, an essential metric for assessing your risk, is calculated as follows:
Margin Level = (Equity / Used Margin) × 100 = ($770 / $230) × 100 = 335%.
At this point, your account metrics reflect a healthy situation:
Margin Level: 335%.
Market Downturn: EUR/USD Drops 500 Pips
Imagine an unforeseen event—EUR/USD plummets by 500 pips, trading at 1.10000. How does this affect your account?
New Used Margin Calculation
With the exchange rate dropping, you need to recalculate the Notional Value:
New Notional Value:
New Notional Value = 10,000 EUR × 1.10000 = $11,000.
New Required Margin:
New Required Margin = $11,000 × 2% = $220.
As a result, your Used Margin now is $220.
Floating P/L Assessment
The drop from 1.15000 to 1.10000 results in a Floating Loss:
Floating Loss = (1.15000 - 1.10000) × 10 = $500 (1 pip = $1).
Equity Update
Your Equity is now recalculated:
Equity = Balance - Used Margin + Floating P/L = $1,000 - $220 - $500 = $280.
New Free Margin Calculation
Free Margin = Equity - Used Margin = $280 - $220 = $60.
New Margin Level
Margin Level = (Equity / Used Margin) × 100 = ($280 / $220) × 100 = 127%.
Your updated metrics after this market movement look like this:
Margin Level: 127%.
Further Decline: EUR/USD Drops an Additional 288 Pips
Now, let’s say EUR/USD falls an additional 288 pips, trading at 1.07120.
Adjusting Used Margin Again
New Notional Value:
New Notional Value = 10,000 EUR × 1.07120 = $10,712.
New Required Margin:
New Required Margin = $10,712 × 2% = $214.
As a result, your Used Margin is now $214.
Floating P/L After Additional Loss
Now your Floating Loss becomes:
Floating Loss = (1.15000 - 1.07120) × 10 = $788.
New Equity Calculation
Your Equity is now:
Equity = Balance - Used Margin + Floating P/L = $1,000 - $214 - $788 = -$2.
Free Margin Update
Your Free Margin is now:
Free Margin = Equity - Used Margin = -$2 - $214 = -$216.
Margin Call Alert
Now, your Margin Level is:
Margin Level = (Equity / Used Margin) × 100 = (-$2 / $214) × 100 = -0.93%.
Since your Margin Level has fallen below the 100% threshold, you’ll receive a Margin Call. Here’s what happens next:
Automatic Liquidation: The broker will automatically close your position to recover the margin.
Balance Update: Your account will now reflect the realized loss from the Floating P/L.
Final Account Metrics
After the liquidation, your account would show:
Balance: $212 (after the realization of the loss).
Equity: $212.
Free Margin: $0.
Conclusion
Trading with a Margin Call Level at 100% can be risky, especially when markets move against your positions. This scenario highlights the importance of risk management, understanding margin dynamics, and the potential for significant losses.
In the next article, we’ll explore a scenario involving brokers that utilize both Margin Call and Stop Out Levels, revealing how these policies can impact your trading strategy differently.
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