When leveraging your position in the EUR/USD pair at 1:100 and opening a $100,000 position with only $1,000 from your account, you run the risk of seeing your equity shrink in the event of a market downturn. Your broker may then issue a “margin call,” and if you fail to pay this requirement, your positions will be closed automatically.
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The stop-out level is a crucial element of trading that can seriously influence your trading journey and financial results. So, what exactly is the stop-out level, why does it occur, and how can you steer clear of it?
Comprehending the Forex Stop-Out Level
The stop-out level automatically liquidates a trader’s position when the account balance surpasses a predetermined threshold. This concept is primarily appropriate in the context of margin trading with leverage, and its consequences can vary among traders.
Margin trading has the prospect of boosting profits, but it comes with substantial risks. Two common events associated with margin trading are stop-outs and margin calls, both of which can lead to substantial losses. For a trader with multiple open positions, some in the red, the account balance often decreases. When exchanging with leverage, traders must preserve a minimum margin requirement. Failure to fulfil this requirement triggers a margin call, which prompts the trader to deposit extra funds to restore the minimum margin and preserve open positions. The broker starts liquidating the positions if the trader doesn’t comply promptly.
Notably, a margin call allows the broker to enable the trader to add more funds to their account instead of immediately selling off the client’s assets. However, if the trader fails to take action promptly and the margin requirement is not met, the stop-out is automatically triggered, leading to the closure of all open positions.
Example of the Stop-Out Level in Forex Trading
Let’s assume a sample to realise the concept of stop-out in trading better. Suppose you use 1:20 leverage to trade the EUR/USD currency pair. For a position of 100,000 euros, your required equity contribution is 5,000 euros. Your broker initiates a margin call if your equity falls to 2,500 euros, equivalent to 50% of your utilised margin.
You can inject additional funds into your account or liquidate part of your assets in response to a margin call. If neither of these actions is taken, the broker has the right to sell off your assets, triggering the stop-out independently.
Some brokers may opt to wait, allowing traders to decide, but this approach can backfire if market trends continue to move against your positions, resulting in further losses.
Determining the Stop-Out Level
Typically, traders don’t need to calculate the stop-out level independently. Most brokers handle this for you. Nevertheless, understanding the concept and how to calculate it can be beneficial.
The stop-out level is essentially a percentage-based required margin level. Specialised calculators can be used to determine it, where traders input data for the account currency, equity, currency pair, buy/sell price, and volume position in lots. The calculator then generates information such as the current price, the distance to the stop-out level, the stop-out price, and the potential losses associated with your positions. Although the stop-out level varies among brokers, it’s commonly set around 20%.
Tips for Avoiding Stop-Outs in Forex
Now that we’ve delved into the stop-out level, let’s explore ways to avoid it. Stop-outs are often feared due to their potential for meaningful losses, making it prudent to seek strategies to mitigate the risk.
Implementing a robust risk management strategy is the most straightforward way to avoid stop-outs. This involves utilising intelligent orders like stop losses to automatically liquidate positions at predefined levels if the market moves against your trade. This strategy ensures that you only incur losses within your risk tolerance.
Limiting the number of open positions is another strategy to prevent reaching the stop-out level. Each open order utilises more equity, thus increasing the risk of nearing the stop-out level.
Lastly, responding promptly and accurately to margin calls is crucial to avoid stop-outs. Failing to do so could lead to a stop-out, resulting in the loss of all your positions.
Conclude
The stop-out level in foreign exchange trading entails substantial danger, and traders should be ready for unfavourable market circumstances and situations that may swiftly turn against them. These dangers may be mitigated, and your trading trip may be protected with a well-thought-out risk management approach.
