Margin Calls: What They Are & How to Avoid Them

One of the most popular things traders like to do is to trade on a margin, i.e., use leverage with their trades. Leverage is an incredibly powerful tool that allows you to control much more instruments than you can buy, however, trading with leverage comes with risks—one of which is getting margin called.

What Are Margin Calls & What Triggers Them?

A margin call is a demand from your brokerage to bring your account up to the required level of equity. This happens when the value of your position decreases and drops below your initial required minimum level of equity, whether it’s due to adverse market movements or because you held onto a losing position for too long.

When this happens, the brokerage will require you to deposit more money into your account or liquidate some of your positions in order to bring the balance back to the required minimum. If you don’t meet this demand, the brokerage has the right to close out any and all trades that are in a losing position, which might be harmful for your portfolio.

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3 Ways to Avoid Margin Calls

1. Have Capital on Hand

The best way to avoid margin calls is to make sure you always have capital on hand. This will ensure that your account equity never drops below the required level, and you’ll be able to remain in control of your positions even when markets are extremely volatile.

2. Utilize Stop Loss Orders

Using stop-loss orders is also a great way to avoid margin calls. This order type allows you to set a specified price level for your position to be automatically closed if the market moves against it. This way you can effectively protect yourself from any sudden and unexpected losses.

3. Trade With a Risk/Reward Ratio

By trading with a risk/reward ratio of at least 1:2, you can drastically reduce your chances of getting margin called. Trading with this ratio means that you’re willing to risk twice as much profit in order to make one unit of profit—which effectively reduces the amount of risk you're taking.

It’s always best to practice trading—choosing a proper trading strategy and being aware of the risks associated with trading on margin can help you avoid costly margin calls that may do more harm than good.