Defining Margin Call in CFD Stock Trading (+ 5 Tips for Avoiding It)

While margin trading—using borrowed funds from a brokerage to trade—is certainly a popular method for trading stocks, it is not for everyone, especially those just starting out.

The basic rule of thumb is that if you are trading stocks, commodities, or forex with three months of emergency savings or a down payment for a house, you should not be trading. Many people are looking to save toward a long-term objective, so margin trading is not something to take lightly.

What Is a Margin Call?

A margin call occurs when the brokerage sees that your margin account is running low on funds, typically because of a losing trade. Instead of allowing the funds to run dry, the brokerage will demand additional capital to keep the trades open.

So, generally, it is your responsibility to enhance your account equity by depositing more money into your account or liquidating your other holdings. Also, if the market is extremely volatile like it was in 1929, 1987, 2001, 2008, or 2020, you might be forced to close your positions at depressed prices, even if you do not want to.

How to Avoid a Margin Call

So, how exactly do you avoid a margin call anyway? Consider the following five tips for avoiding a margin call when trading:

1. Don't Use Borrowed Funds

Using borrowed money when you are in the middle of a bull run might seem like a smart move. But when stocks slip into a bear market, your account will be crushed. Do not invest in CFDs with money you cannot afford to lose. An investment in CFDs carries a high degree of risk to the investor and, due to fluctuations in value, the investor may not get back the amount they invested.

2. Try to Use Less Than the Maximum Margin Offered by the Brokerage

It can be tempting to maximize your margins if offered by the brokerage, but this is highly risky and can result in significant financial ruin.

3. Monitor Your Account

By having a margin account, it is your responsibility to regularly keep track of your accounts and make sure that you are adapting accordingly, whether buying at your price target or selling when it is in freefall.

4. Avoid Volatile Securities and Diversify Your Portfolio

One of the best ways to avert a margin call is to stop investing in volatile securities when a frenzy occurs. Moreover, diversifying your portfolio with low-risk securities, from utilities to index funds, might be a good idea.

5. Take Advantage of Price Alerts and Stop-Loss Orders

Finally, use price alerts to your advantage by being notified if the stock has reached a level where you are comfortable buying or selling. In addition, stop-loss orders consist of placing an order to automatically close your position once the instrument hits your specified price point.

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Final Words

The existence of margin trading shows why everyone needs to have some extra cash on hand in the event of a margin call. Even an extra one or two percent in an easily accessible savings account can potentially prevent a financial disaster.

Fortunately, there are ways to avert a margin call—and they all include being aware of the market and being responsible with your money.