Understanding the Importance of Stop-out Level & Aspects to Consider

An Essential aspect for traders is maintaining a margin level of at least 100% to prevent potential issues. The more free margin a trader has, the more simultaneous trades they can open. However, if the margin level reaches a predetermined percentage, the broker will initiate a margin call; This requires traders to either refill their account balance or close some positions to restore the balance.

A stop-out occurs when existing positions work against the traders, resulting in losses and decreased available equity. When the margin level reaches 50%, the broker will automatically close positions until the margin level is restored to its previous level.

Impact Of Stop-out Level

The stop-out level is when a trader's positions are automatically closed if their account balance reaches a predetermined level; This is important to understand when using leverage in margin trading, as it can impact traders differently. While margin trading can potentially increase profits, it also comes with substantial risk. Stop-outs and margin calls are two common events that can lead to significant losses for traders engaged in margin trading.

When a trader has multiple open positions, including some that are incurring losses, it is common to see a decrease in the trader's account balance. When using leverage in trading, traders must maintain a certain minimum margin. The brokerages will issue a margin call if the trader fails to meet this requirement. The trader is urged to deposit additional funds to cover the minimum margin and protect their open positions. The broker can begin liquidating the positions if the trader does not comply promptly.

One important point is that a margin call allows the broker to wait for the trader to provide the necessary funds rather than immediately selling off the trader's assets.

However, the situation can worsen if the trader does not add more funds to their account on time. Each broker has a threshold for the margin level that must be achieved before a stop-out is automatically triggered. Once this threshold is reached, there is no turning back - the stop-out will activate, and all open positions will be closed until the margin level is restored.

How To Determine?

In most cases, there's no need to figure out the stop-out level alone. The majority of brokers in the market will handle this for you. However, it's still beneficial to understand what a stop-out is and how to calculate it. A stop-out is essentially a required margin level expressed as a percentage.

There is a method to determine the stop-out level using specialised calculators. Forex traders must input data for the account currency, equity, currency pair, buy/sell price, and volume position in lots into the stop-out level calculator. The calculator will then provide 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. These tools can assist traders in foreseeing the worst-case scenarios.

While the stop-out level can vary among brokers, it is commonly set at around 20%. Having this knowledge will help you make more informed trading decisions.

Prevention

To avoid stop-outs in FX trading, it is important to implement effective strategies. Stop-outs can result in significant losses, so it is natural for traders to be concerned. One key strategy is a solid risk management approach, which involves using intelligent orders like stop losses. These orders allow traders to set predetermined levels at which their positions will be automatically liquidated if the market moves against them. By implementing this strategy, traders can prevent losses that exceed their risk tolerance.

Another way to avoid stop-outs is to be mindful of the number of open positions at any time. Each open order utilises more equity, which increases the risk of reaching the stop-out level. It is advisable to carefully manage the number of positions open to minimise this risk.

By following these strategies, traders can reduce the likelihood of encountering stop-outs and the associated losses. Implementing a solid risk management strategy and being mindful of the number of open positions are effective measures to mitigate the risk of stop-outs in FX trading.

Examples for Better Understanding

Let's look at a practical example to better understand the stop-out concept in Forex trading. Suppose you're using a leverage ratio 1:20 to trade the EUR/USD currency pair. For a position of 100,000 euros, you must have at least 5,000 euros in equity. Your broker will issue a margin call if your equity exceeds 2,500 euros, 50% of your used margin.

When you receive a margin call, you have two options: adding more funds to your account or selling some of your assets. If you don't act, your broker can sell off your assets, activating the stop-out process independently. Although some brokers might allow traders to decide themselves, this can be risky if the market continues to move against your positions, resulting in further losses.

Bottom Line

Stop-out can be highly risky, particularly if you lack a well-defined risk management strategy. Individual traders must anticipate unfavourable market conditions and unforeseen scenarios that can rapidly work against them. By adequately preparing, traders can mitigate potential risks and safeguard their investments.