Your neighbor at a party is telling a captivating story of how he had experienced a margin call from his broker. Like the rest of the crowd, you put on a face that is a combination of shock and sympathy, but in your head, you are thinking “What the heck is he talking about?”

In the foreign exchange market, everybody uses leverage to trade currency. Basically we borrow money from our brokers to carry out our trade. But when we borrow too much money and our positions start to go against us, the broker gets nervous because at this point there is a possibility that we won’t be able to pay back the money you borrowed. They protect themselves by closing all your open positions.

A margin call occurs when you no longer have enough margin to cover your losses. Every broker have a different margin policy so be sure to read and understand your broker’s stance on the dreaded margin call.

Margin call example:
You just got a nice year end bonus and decided to play the foreign exchange market. Say you start off with $5000 in your account. Your account will look like this initially:

Balance: $5000
Net Asset Value: $5000
Used margin: $0
Available margin: $5000

The balance is how much money is in your account. The net asset value is your balance plus all the unrealized gains and losses of your open positions. The used margin is how much of your own money you are putting up. The available margin is calculated by taking the net asset value subtracted by the used margin.

You decide to test the waters and buy one standard lot using 100:1 margin, your account will look like this:

Balance: $5000
Net Asset Value: $5000
Used margin: $1000
Available margin: $4000

There was a news release which sent the currency pair spiraling down 200 pips. Since this is a standard lot, each pip is worth $10. The unrealized loss is $2000. Here is how your account will look like after the news release:

Balance: $5000
Net Asset Value: $3000
Used margin: $1000
Available margin: $2000

Wow, you just lost $2000 from that one news release. The balance is still $5000 because you have not closed your positions, but your account is actually worth only $3000 now. You decide that the market overreacted to the news release and believe that the price will bounce up over the next few hours.

You were wrong. There was another news release that sent your currency pair down another 200 pips. Your account will look like this now:

Balance: $5000
Net Asset Value: $1000
Used Margin: $1000
Available Margin: $0

What a day! You lost $4000 in one day. Since your broker sees that your net asset value is equal to your used margin, a margin call occurs. They close all your positions and your losses are now locked in. Here is how your final account will look like:

Balance: $1000
Net Asset Value: $1000
Used Margin: $0
Available Margin: $0

All your open positions are now closed and you have $1000 left in your account.

Can margin call be a good thing?

Surely nobody likes to get a margin call. It means that all your open positions are closed for you and your unrealized losses become realized losses. However usually after the margin call you will still have some money left in your account.

Imagine that your broker has never heard of a margin call. Continuing with our example from above, the margin call was never implemented and you still decide to hang on to your currency pair. It’s not your lucky day. The currency pair lost another 500 pips. Your account looks like this now:

Balance $5000
Net Asset Value: - $4000
Used Margin: $1000
Available Margin: $0

Instead of walking away with $1000, you are now down $4000. Margin calls can be a good thing because it can prevent you from losing more money than you have access to. It can prevent you from losing your house!

Summary

Our example here may have been unrealistic. Prices don’t normally drop 200 pips multiple times in one day. However, it does illustrate clearly how the margin call works and when it will be implemented.

Once again, not every broker has the same margin call policy. So be sure to read up or call their customer service line to find out under what circumstances a margin call will occur.

Related Links
Forex Basics - The ABCs of Forex Trading
5 Secrets Characteristics of Successful Forex Traders
Choosing a Forex Broker - The Common Sense Way