Forex trades are almost entirely margined — in effect; the broker gives you the opportunity to make trades with money you don’t have. The average leverage on the forex is very high — between 50:1 and 200:1. Leveraging an account to the maximum 200:1 ratio means that even the slightest drop in the value of your active trades can wipe you out. That’s when you get a margin call from the broker. If you want to continue trading, you’ll have to put more money in your forex account. So the simplest answer to the question “What is a margin call” is that it’s a demand from your broker to put more money in your account if you want to continue to trade.
The more complicated question is: how and why does this happen?
A Moment of Reflection
Before considering that question, reflect for a moment on real estate. Most Americans are familiar with the real estate market, where the majority of residential purchases require the buyer to put up a minimum of 20 percent of the value of the house before the mortgage company supplies the remaining 80 percent. That’s effectively five to one leveraging. If the mortgage industry operated like the forex, with 200:1 leveraging, you could buy a $500,000 house with a down payment not of $100,000, but of only $2,500.
Consider also that the mortgage industry also has extensive qualifications you need to meet to take out the loan in the first place, beginning with proof of income. Your mortgage payments can only total around 30 to 40 percent of annual household earnings. You also have to have a relatively extensive record of paying your bills on time.
Contrast that with the forex where the only thing you need to open your account is an ID and a credit or debit card. That’s right — you don’t need to put up any money at all. Effectively, you’re trading with borrowed money from the start. And you don’t have to demonstrate that you can pay back the money if you lose. It can just go on your credit card as high-interest debt you’ll pay back over months or even years.
One last difference between the real estate market and the forex is that the ups and down in the real estate industry are over relatively long periods of time. In a single day or even a single month, the change in the value of your house probably won’t vary more than a few tenths of a percent. “Highly volatile” in the real estate industry might be something like a 10 percent value shift over a year. Normal volatility in the currency markets can wipe out highly leveraged traders in a matter of minutes, even seconds.
What Does This Suggest?
If you think that the way the forex operates is a recipe for disaster you’re right — not for brokers, but for the trader who’s quickly in over his head. The average forex investor loses — more than two-thirds lose money, in fact. And it only takes on average about four months for the average trader to be so discouraged or broke or both that the account closes and he’s out of the market entirely. With that in mind, consider the likelihood of the average forex trader getting a margin call.
What Causes Margin Calls
In a 2014 article in DailyFX, a well-known online forex market newsletter, trading instructor Tyler Yell identifies the trading behaviors that produce margin calls in a nutshell: “the use of excessive leverage with inadequate capital while holding on to losing trades for too long when they should have been cut.”
Avoiding Margin Calls
Two simple ways to prevent a margin call are keeping your account well-capitalized and learning to cut your losses short to let your profits run. These two simple components should be part of any Forex Trading Strategy. Well-capitalized accounts are not just a ‘nice thing to have,’ but rather a necessity in nearly all financial markets. The ability to close out a trade that is no longer working in the manner you hoped helps to ensure you are still around for the next opportunity the market presents.