Margin call and stop out

Margin level is a ratio, not a sum of money. The broker divides your equity by the margin used on open positions, then multiplies by 100 to make a percentage. Equity is your balance plus or minus the profit and loss on everything still open. Margin used is the deposit the broker set aside when the positions were opened, and it does not move with price.

Take a balance of R10 000 and one open USD/ZAR position with R2 000 set aside as margin. If the trade is flat, equity is R10 000 and margin level is R10 000 divided by R2 000, times 100, which is 500%. Nothing has been won or lost. The R2 000 is still yours; it is only locked while the position is open.

Now let the trade run against you by R8 500. Equity falls to R1 500. Margin used is still R2 000. Margin level is R1 500 divided by R2 000, times 100, which is 75%. The drop from 500% to 75% came from the loss, not from the margin used. This is why a large margin level on a small position is not a cushion you can ignore: it shrinks as equity shrinks, and it can shrink fast on a leveraged pair.

The percentages at which a broker acts are set by that broker, and they vary. A margin call line might sit at 100%, or 80%, or 50%. A stop out line might sit at 50%, or 20%, or lower. Read your own broker's schedule before you trade, because the arithmetic below only becomes useful once you know which two numbers that schedule names.

A margin call is a notification. The broker tells you that margin level has fallen to its stated line. In most cases it does not close anything at that moment. It is a request to add funds or to reduce exposure. The word call is old and misleading: no one telephones you, and no one waits for your answer.

A stop out is an action. When margin level falls to the broker's stop out line, the broker closes positions without asking. It chooses which ones. Some brokers close the largest losing position first, some close the most recently opened one, and some close everything at once. You do not get to pick, and you may not get a second notification before it happens.

Between the two lines there is a gap, and the gap is where your decisions live. On the example above, 100% margin level means equity of R2 000. The 50% line means equity of R1 000. The distance from one to the other is R1 000 of equity, which on a USD/ZAR position is a fixed number of rand of loss, not a fixed amount of time. Price can cover that distance in minutes or in days.

Closing does not create a new loss by itself. It converts an unrealised loss into a realised one. If equity was R1 000 when the stop out fired, you are left with R1 000 in cash, whatever the position size was. The broker's fee or spread on the closing trade comes out of that figure, and rounding can move the final number slightly away from the line you calculated.

You can turn the two lines into rand before you commit. Multiply the margin used by the margin call percentage, then divide by 100. With R2 000 margin used and a 100% line, the equity at which the call arrives is R2 000. With a 50% stop out line, it is R1 000. Subtract each from your current equity to get the loss each line allows.

Suppose your equity is R10 000 and margin used is R2 000. The call line at R2 000 equity is R8 000 of loss away. The stop out line at R1 000 equity is R9 000 of loss away. Those are the distances, in rand, that the market has to travel against you. If your position loses R500 for every 1 000 pips of adverse movement on USD/ZAR, then R9 000 of loss is 18 000 pips, and you can compare that with how far the pair has moved in a week.

The same arithmetic tells you what adding funds does. A deposit raises equity, which raises margin level and pushes both lines further away in rand terms. It does not change the position, the price, or the direction. It buys distance, and distance is the only thing it buys.

Two things can move the lines without any price change. Overnight swap is added to or subtracted from equity each day the position is held, and it varies between brokers and between buy and sell directions. A second open position raises margin used, which lowers margin level even if the first position has not moved. Both effects are why the distance you calculated this morning may be shorter by the evening.