In trading, traders often borrow funds to increase their exposure to the market. Brokers provide financing options for traders to leverage their own funds. These accounts are known as "Margin Accounts" in traditional finance. However, Margin Accounts also bring the risk of Margin Risk, which refers to the risk of getting a Margin Call from the broker.
What is a Margin Call
A Margin Call occurs when the account balance falls below the minimum requirements set by the broker. In such a case, the broker will liquidate the associated positions at market prices. Traders are notified via email or other means of communication that their positions were liquidated due to the Margin Call.
Let’s discuss an example.
John has a trading balance of $1,000, and he wants to use leverage of 1:100 (100x) to buy 100 lots of Asset X, using his $1,000 funds. Let's say that 1 lot of Asset X costs $1,000. Without any leverage, John's balance would be $1,000, which is equivalent to 1 lot of Asset X. However, his broker offers him financing of up to 100x, which means his hypothetical balance can reach $100,000 (1,000 x 100), equivalent to 1,000 lots of Asset X. If John wants to buy 100 lots of Asset X using all the leverage available, he would have to put $1,000 (100,000 / 100) of his funds.
Before opening the trade, John expects the price of Asset X to increase. He opens a Long position for 100 lots in Asset X. It is important to keep in mind that all fluctuations in Asset X will be reflected in John's balance. For instance, if the price increases by 10%, John will make $10,000 (10% x 100,000). So, a 10% increase in the asset price would translate to a 1000% gain for John.
However, what most beginners forget is to look at the other side of the coin. In case John's prediction on price is wrong and it starts dropping, it would take only a 1% price drop to wipe out his entire capital. In an event like that, when John's funds decrease to 0, the broker will instantly sell John's position to protect its capital and take his money back.
So, can you avoid Margin Calls?
Risk management is one of the most crucial aspects of trading, yet it's often overlooked. Before opening a position, it's important to have clear expectations of your potential profits and losses. This allows you to construct a much cleaner risk/reward structure that suits your appetite. Many traders use automatic stop-loss triggers to hard cap their potential losses. The distance from the entry point to stop loss should be determined according to the size of the position and available funds. However, the size of your position should not be the only determining factor for the size of your stop loss. It's generally recommended not to risk more than 5% of your total balance in each trade, but many experienced traders believe that this amount of risk is still too high. Losing four trades in a row would mean losing 20% of your total balance, which is a scary thought if you use margin and could lead to liquidation in many scenarios. In addition, to come back to the starting point, you would need to make 25% in profits. Remember, it's easier to limit losses than to earn them back.
Larger drawdowns can also be psychologically difficult for most beginner traders. When experiencing a drawdown, a trader may start acting emotionally out of a desire to recoup and start opening even bigger positions to try to recover. However, this is no longer a trade, it's a gambling game, and it's more profitable to play the casino.
Our experience
It is important to never risk more than 2% of your trading account in any trade. If you are just starting out, it is recommended to start with a 1% risk instead. Once you feel confident in your trading strategy, you can slightly increase the size of your position. However, it's important to note that 5% is too much for most trading strategies. Even the best traders can make 4 or 5 losing trades in a row.
If you plan to trade using a large amount of money, it is important to have the appropriate amount of capital to ensure safety. However, this doesn’t mean that you cannot open a position for $1000 while having $1000 in your trading account. It only means that you should risk 2% of $1000, which is equivalent to $20. It's important to keep in mind that the number of positions you open at the same time determines your risk every moment.
If you risk only 2% of your trading deposit in one trade, do not think that you can open 10 positions at once, because doing so could lead to a margin call. Additionally, in the cryptocurrency market, all trading pairs are correlated with BTCUSDT. There are many reasons for this, which we'll discuss in other articles of our blog. It's important to remember that bigger market movements not in your favor will double your losses.
Even if you open only two positions, but trade correlated pairs, you still risk 2% in one trade. However, you can risk 1% on a long position, for example on BTCSUSDT, and at the same time risk 1% on a long position on ATOMUSDT. It's important to avoid opening multiple positions on correlated pairs, or at least be aware of your possible risks. In conclusion, it's crucial to manage your risks wisely to ensure a successful trading journey.
Stay tuned!