What is a Margin Call?
What is a Margin Call
A margin call is a request from an asset lender to increase the amount of assets held as collateral in a trading account using borrowed funds, also known as a margin account. Margin calls are made following price movement against a trader's margin positions that the lender deems significant enough to compromise the recovery of their margin loan capital.
Crypto traders looking to maximize their potential returns can borrow from certain exchanges and combine them with their own assets. Margin, also known as leverage trading, allows investors to place much larger trades than would be possible without these borrowed funds.
Margin trading has risks – especially given the highly volatile nature of crypto markets. One of these is “receiving an urgent demand for additional collateral, known as a margin call. ”
What Triggers a Margin Call?
A margin call is triggered when an investor's margin collateral falls below a certain level or percentage requirement required by an exchange. This level is called maintenance margin.
A margin call occurs when one or more of the open positions in a margin account decreases in value. If a trader's positions are significantly leveraged (consisting of several times more borrowed money than his own), a margin call may be triggered by a relatively small percentage decline.
If a trader fails to meet the requirements of the margin call, the lender will close out the trader's open positions in a process known as “liquidation” and retain the resulting cash balance to meet the margin call.
One of the most important things to understand about margin calls is that your open positions can be sold by the lender without your real-time consent.
This is a condition you must agree to when you sign up for a margin loan. The lender has the ultimate power when you need to increase the equity in your margin account and can sell your assets to cover the shortfall.
Most exchanges automatically encourage investors to add additional funds via email, but they don't always have to do so. Whether or not you receive a margin call notice, an exchange may take immediate action to close your open positions if the maintenance margin falls below the required minimum, regardless of the cost to the trader.
An exchange may choose to cover all open positions or margin calls.
In the second scenario, positions are typically closed on a first-in, first-out (FIFO) basis. This means that if you have profitable positions opened before losing trades, these profitable positions will be at risk of liquidation first.
Moreover, the liquidation is carried out at the best possible market price, regardless of how low this price may be. If market conditions are particularly volatile or large open positions are sold into an illiquid market, this can often increase losses
How Do You Calculate Margin Level?
Maintenance margin, or “margin level” on some trading platforms such as Kraken, is the percentage-based ratio of your account equity to the amount used to open margin positions.
Equity is the sum of your collateral holdings plus or minus any unrealized profit or loss on open positions.
Equity = (value of collateral assets – borrowed funds)
Margin used is the amount of funds required to open a margin position. Dividing the total trade amount by the leverage level used to open the trade produces the amount of margin used. For example, if a $1,000 position is opened using 2x leverage, the margin used is $500.
For long positions, the following equations can be used to determine how much assets can fall before reaching the minimum maintenance margin (usually 80% on Kraken) and 40% on Kraken (liquidation level):
Margin Call Price = Entry Price - ( ( Equity - ( Margin Used x 0.8 ) ) / Open Volume )
Liquidation Price = Entry Price - ((Equity - (Margin Used x 0.4)) / Open Volume)
For short positions, a separate set of equations is used to determine the maintenance margin and liquidation levels. This is because the quote currency (cash or stablecoin) is used for long margin positions, while the base currency (BTC, ETH, etc.) is used for short margin positions.
Because the value of the base currency in cash fluctuates (for example, the value of BTC in USD is constantly changing), a different calculation must be made.
Margin Call Price = Leverage x (Trading Balance + (Entry Price x Open Volume)) / (Open Volume x (0.8 + Leverage))
Liquidation Price = Leverage x (Trading Balance + (Entry Price x Open Volume)) / (Open Volume x (0.4 + Leverage))
Avoiding Margin Calls,
It is important to understand what triggers a margin call and what steps can be taken to minimize the risk of being forced to sell margin by the lender.
When an investor uses an asset they own as collateral for a leveraged position, the value of their collateral fluctuates as the asset price rises or falls. If the equity in their account falls below the broker's required maintenance margin amount, a margin call may be issued.
The same goes for investors using cryptocurrency as collateral. If the value of funds held in the margin account falls below the maintenance margin, sharp changes in the value of open crypto positions in fiat can quickly trigger margin calls.
The following considerations and strategies can help minimize the likelihood of a margin call:
Prepare for volatility: Leaving a significant cushion of funds in a margin account can help protect investors from a sudden drop in the value of their loan collateral. Keeping additional liquid supplies available in case they are needed to regain required minimum margin maintenance can help prevent forced liquidation.
Setting a personal trigger point: Traders can use stop loss orders to manage risk by choosing to close margin positions before the risk of a margin call becomes a concern. This approach allows a trader to sell margin calls in a more orderly and price-sensitive manner than market order forced liquidations generally provide.
Monitoring: In addition to actively monitoring their accounts, traders can also use alerts to notify them when the value of their open positions drops to certain levels.
