Archive for category: Preliminary articles

There are three types of market analysis:

1. Technical Analysis
2. Fundamental Analysis
3. Sentiment Analysis

There has always been a constant debate as to which analysis is better, but to tell you the truth, you need to know all three.

It’s kind of like standing on a three-legged stool.

If one of the legs is weak, the stool will break under your weight and you’ll fall flat on your face.

The same holds true in trading.

Oh, wait. Since the stool is supposed to represent how a trader goes about thinking and analyzing the market, it’s missing a brain.

But wait! The stool needs more brains!

There technically should be three brains….to represent the three different types of thought process…

Ahhh. There we go.

You need to have three “brains” when thinking about the market.

If your analysis on any of the three types of analysis is weak and you ignore it, there’s a good chance that it will cause you to lose out on your trade!

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 the 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 that 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 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 is 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.

In forex trading, a Stop Out Level is when your Margin Level falls to a specific percentage (%) level in which one or all of your open positions are closed automatically (“liquidated”) by your broker.

This liquidation happens because the trading account can no longer support the open positions due to a lack of margin.

More specifically, the Stop Out Level is when the Equity is lower than a specific percentage of your Used Margin.

If this level is reached, your broker will automatically start closing out your trades starting with the most unprofitable one until your Margin Level is back above the Stop Out Level. 

If your Margin Level is at or below the Stop Out Level, the broker will close any or all of your open positions as quickly as possible in order to protect you from possibly incurring further losses.

This act of closing your positions is called a Stop Out.

Keep in mind that a Stop Out is not discretionary. Once the liquidation process has started, it is usually not possible to stop it since the process is automated.

Your broker’s customer support team will probably NOT be able to help you aside from lending an ear while you weep loudly over the phone.

The Stop Out Level is also known as the Margin Closeout Value, Liquidation Margin, or Minimum Required Margin.

Example: Stop Out Level at 20%

Let’s say your forex broker has a Stop Out Level at 20%.

This means that your trading platform will automatically close your position if your Margin Level reaches 20%.

Stop Out Level = Margin Level @ 20%

Let’s continue with the example from the previous lesson, What is a Margin Call Level?

You’ve already received a Margin Call when the Margin Level had reached 100% but still decide not to deposit more funds because you think the market will turn.

Not only are you a sucky trader, but you’re a crazy trader also. A sucky crazy trader.

Anyways, your sucky crazy self ends up…absolutely WRONG.

The market continues to fall.

You’re now down 960 pips.

At $1/pip, you now have a floating loss of $960!

This means your Equity is now $40.

Equity = Balance + Floating P/L

$40 = $1000 - $960

Your Margin Level is now 20%.

Margin Level = (Equity / Used Margin) x 100%

20% = ($40 / $200) x 100%

*Used Margin can’t go below $200 because that’s the Required Margin that was needed to open the position in the first place.

At this point, your position will be automatically closed (“liquidated”).

When your position is closed, the Used Margin that was “locked up” will be released.

It will become Free Margin.

The end result for you will be depressing though.

Your floating loss of $960 will be “realized”, and your new Balance will be $40!

Since you don’t have any open trades, your Equity and Free Margin will also be $40.

Here’s how your account metrics would look like in your trading platform at each Margin Level threshold:

If you experience a Stop Out and see the aftermath in your account, this is how your eyes feel…

If you had multiple positions open, the broker usually closes the least profitable position first.

Each position that is closed “releases” Used Margin, which increases your Margin Level.

But if closing this position is still not enough to get back the Margin Level above 20%, your broker will continue to close positions until it does.

The Stop Out Level is meant to prevent you from losing more money than you have deposited.

If your trade continued to keep losing, eventually, you’d have no more money in your account and you’d end up with a negative account balance!

Brokers would prefer not to have to come knocking on your door with a baseball bat to collect the unpaid balance, so a Stop Out is meant to try and… STOP… your Balance from going negative.

What if I have multiple positions open?

The example above covered the scenario with you trading a single position. But what if you had MULTIPLE positions open?

Hmmm.

Sounds like you love gambling so here’s an example of how the liquidation process would work if you had two or more positions open.

Each broker has its own specific liquidation process so be sure to check with yours. BUT this is a popular approach and will at least give you a good idea of what kind of horror you might experience if you’re trading too BIG.

Let’s pretend the Stop Out level is at 100%.

If at any point, the Margin Level drops below 100% of the margin required.. you will experience an AUTO LIQUIDATION of the position that has the largest unrealized loss! 

So if you have multiple positions, the open position with the greatest unrealized loss is closed first, followed by the next largest losing position, followed by the next largest losing position, and so on, UNTIL the Margin Level (maintenance margin) is back to 100% or higher.

Depending on the size and unrealized P&L of the open positions, all your open positions could be liquidated in order to meet the margin requirement!

Remember, YOU, and YOU alone, are responsible for monitoring your account and making sure you are maintaining the required margin at all times to support your open positions.

You’ve been warned. Don’t be crying to your broker when your position gets auto-liquated.

You can still cry of course. But only in front of a mirror.

Now that we’ve covered all the important metrics that you need to know in your trading platform, let’s take everything you’ve learned so far about margin trading and put it all together using different trading scenarios.

Margin Level allows you to know how much of your funds are available for new trades.

The higher the Margin Level, the more Free Margin you have available to trade.

The lower the Margin Level, the less Free Margin available to trade, which could result in something very bad…like a Margin Call or a Stop Out (which will be discussed later).

How to Calculate Margin Level

Here’s how to calculate Margin Level::

Margin Level = (Equity / Used Margin) x 100%

Your trading platform will automatically calculate and display your Margin Level.

If you don’t have any trades open, your Margin Level will be ZERO.

Margin Level is very important. Forex brokers use margin levels to determine whether you can open additional positions.

Different brokers set different Margin Level limits, but most brokers set this limit at 100%.

This means that when your Equity is equal to or less than your Used Margin, you will NOT be able to open any new positions.

If you want to open new positions, you will have to close existing positions first.

Example #1: Open a long USD/JPY position with 1 mini lot

Let’s say you have an account balance of $1,000.

Step 1: Calculate Required Margin

You want to go long USD/JPY and want to open 1 mini lot (10,000 units) position. The Margin Requirement is 4%.

How much margin (Required Margin) will you need to open the position?

Since USD is the base currency. this mini lot is 10,000 dollars, which means the position’s Notional Value is $10,000.

Required Margin = Notional Value x Margin Requirement

$400 = $10,000 x .04

Assuming your trading account is denominated in USD since the Margin Requirement is 4%, the Required Margin will be $400.

Step 2: Calculate Used Margin

Aside from the trade we just entered, there aren’t any other trades open.

Since we just have a single position open, the Used Margin will be the same as Required Margin.

Step 3: Calculate Equity

Let’s assume that the price has moved slightly in your favor and your position is now trading at breakeven.

This means that your Floating P/L is $0.

Let’s calculate the Equity:

Equity = Account Balance + Floating Profits (or Losses)

$1,000 = $1,000 + $0

The Equity in your account is now $1,000.

Step 4: Calculate Margin Level

Now that we know the Equity, we can now calculate the Margin Level:

Margin Level = (Equity / Used Margin) x 100%

250% = ($1,000 / $400) x 100%

The Margin Level is 250%.

If the Margin Level is 100% or less, most trading platforms will not allow you to open new trades.

In the example, since your current Margin Level is 250%, which is way above 100%, you’ll still be able to open new trades.

Equity is the current value of the account and fluctuates with every tick when looking at your trading platform on your screen.

It is the sum of your account balance and all floating (unrealized) profits or losses associated with your open positions.

As your current trades rise or fall in value, so does your Equity.

How to Calculate Equity If You Have No Trades Open

If you do NOT have any open positions, then your Equity is the same as your Balance.

Equity = Account Balance

Example: Account Equity When You Have No Open Trades

You deposit $1,000 in your trading account.

Since you haven’t opened any trades yet, your Balance and Equity is the same.

How to Calculate Equity If You Have Trades Open

If you have open positions, your Equity is the sum of your account balance and your account’s floating P/L.

Equity = Account Balance + Floating Profits (or Losses)

Example: Account Equity When an Existing Trade  is  Losing

You deposit $1,000 in your trading account.

Beyoncé tweets that she’s shorting GBP/USD. Because she’s Beyoncé, you follow what she says and go short also.

Price moves immediately against you and your trade shows a floating loss of $50.

Equity = Account Balance + Floating Profits (or Losses)

$950 = $1,000 + (-$50)

The Equity in your account is now $950.

Example: Account Equity When an Existing Trade is Winning

Beyoncé tweets again and says she’s changed her mind. She’s now long GBP/USD.

Not only is she Crazy in Love, but she seems crazy in trading also.

Price moves immediately in your favor and your trade shows a floating gain of $100.

Equity = Account Balance + Floating Profits (or Losses)

$1,100 = $1,000 + $100

The Equity in your account is now $1,100.

Your account equity continuously fluctuates with the current market prices as long as you have any open positions.

Equity shows the “TEMPORARY” value of your account at the current time. (Unlike a tattoo, which is…not temporary.)

That’s why Equity is seen as a “floating account balance“. It will only become your “real account balance” if you were to close all your trades immediately.

What is the difference between Balance and Equity?

Let’s start with a simple answer.

If your account is “flat” or does NOT have any positions open, then your Balance and Equity are the SAME.

But if you do have open positions, this is when the Balance and Equity differ.

• The Balance reflects your profit/loss from closed positions.
• The Equity reflects the real-time calculation of your profit/loss. The Equity takes into account both open AND closed positions.

This means that when you’re looking at your Balance, it is NOT the actual real-time amount of your funds.

Since Equity includes current profits or losses from open trades, it is Equity that shows the real-time amount of your funds.

It’s possible to have a very large Balance, but very small Equity.

This happens when your open positions have a large unrealized (floating) losses.

For example, if your Balance is $1,000, and you have an open trade that has a floating loss of $900.

Your Equity is only $100.

Recap

In this lesson, we learned about the following:

• Equity is your account balance plus the floating profit (or loss) of all your open positions.
• Equity represents the “real-time” value of your account.

In previous lessons, we learned:

• What is Margin Trading? Learn why it’s important to understand how your margin account works.
• What is Balance? Your account balance is the cash you have available in your trading account.
• What is Unrealized and Realized P/L? Know how profit or losses affect your account balance.
• What is Margin? Required Margin is the amount of money that is set aside and “locked up” when you open a position.
• What is Used Margin? Used Margin is the total amount of margin that’s currently “locked up” to maintain all open positions.

Let’s move on and learn about the concept of Free Margin.