In forex trading, a trader operates with a leverage or debt given to them by their broker for every amount they set aside for trading. In a leveraged market, the trader is able to gain more profits using a small amount of money by taking advantage of the amount lent to them by the broker. However, the broker will close any trade if the available margin level falls below the required amount. In this article you will learn:
- What is a stop out level in forex trading?
- Other terms associated with stop out level
- Examples of a stop out level
- How to avoid or prevent a stop out
What is a stop out level in forex?
A stop out level refers to a point in which a forex broker closes all the open positions of a forex trader automatically due to a significant reduction of their margin levels. A forex trader closes the open trades when the margin level reaches a certain minimum level so that the trader’s losses do not exceed the trading capital.
Each forex broker has its own stop out level and margin requirement. For example, FXPesa has a stop out level of 30%. This means that the broker closes all open positions if the margin level reaches 30%. A margin level of 30% means that your equity is 30% of the used margin. Thus, the broker closes the trades before the account’s equity is eroded by losses.
Other important terms
You need to know other terms in forex that affect the stop out level. For instance, leverage ratio refers to the amount of money that the broker lends the trader for every dollar in their account. For instance, a leverage of 300:1 means that the trader is able to control 300 units of currency for every dollar in their account. Therefore, a leverage magnifies both losses and profits in a trader’s account. If the investor is making losses, the leverage works against them because it reduces their margin level immensely, leading to a sop out potentially.
A margin call refers to the notification given by a forex broker to the trader when the margin level of the customer falls below certain level. FXPesa, for instance, gives a margin call at 100% margin level. This means that the company will notify the trader when their margin level falls below 100% so that the trader can add more funds to support the existing trades or to close the losing positions.
If the investor does not close the losing trades or add funds to increase the margin, the margin level may fall further as losses increase. A fall below 30% will then cause a stop out where the broker closes all losing positions automatically.
Example of a stop out level
Assume you have opened an account with FXPesa, which has a margin call of 100%, and stop out level of 30%. You then deposit $1000 to your trading account. Then you start trading by buying EUR/USD with a margin of $500 – this is the used margin.
If the loss on the trade comes to $500. Your equity will fall to $500 (1000-500). This amount is already 100% of your used margin. You then receive a margin call from FXPesa.
If the losses increase to $850, your new equity will be $150 (1000-850). This is already 30% of the used margin, and you are honorably stopped out. Your broker will automatically close the open position to prevent further losses.
How to avoid or prevent a stop out
A stop out is one of the most painful experiences of a forex trader. Sometimes you get stopped out and the market reverses, meaning that you could still make profits with the same losing positions. Here are the steps you need to take to avoid stop outs:
- Trade a small percentage of your equity in one trade. Most prudent traders often use 2.5% or 5% of their equity to trade. In this case, you can still remain with a lot of money to trade if you are stopped out.
- Use a small leverage, if necessary. It would even better not to use leverage at all, but that is not practicable for small traders. Leverage magnifies losses, and more losses cause a stop out. So you minimize losses and reduce chances of a stop out by using small leverages such as 50:1 or 30:1. Read more on how to stop loss (S/L) and take profit (T/L).
- Set stop loss and take profit. After analyzing the market, identify a point where you can comfortably take a loss to avoid further losses, and a point where you can take good profit.
- Monitor your trade: keep an eye on your trade to ensure that it is still within manageable levels. If you see that it is going wrong after some time, close the losing positions.
- Respect the margin call. Most traders make the mistake of ignoring a margin call. When you get the margin call alert, act! Either money to your account to increase your equity or close your losing positions.
