In the previous lesson, we discussed the Margin Call Level. And now in this lesson, we shall understand a similar concept called Stop Out Level.
What is Stop Out Level?
Stop Out Level is a point where the Margin Level falls below a specific level (set by the broker) which forces the broker to close one or all the positions without the account holder’s consent. This liquidation happens because of the unavailability of Margin in the account.
Technically, Stop Out Level is a level when the Equity value becomes lower than the Used Margin value. The explanation for this will be discussed later in the lesson.
And the process of positions being closed is called Stop Out. So, once the Stop Out Level is hit and the Margin goes below it, the Stop Out action is initiated. Note that, this Stop Out act commences, it is not possible to stop this process, as the complete process is automated.
Step by Step procedure of occurrence of a Stop Out
To understand the terminology behind Stop Out in a margin account, it is indispensable to know the concepts on Margin Level, Equity, Floating Margin and Used Margin.
When you place a trade, the Equity is continuously calculated using the Balance and floating P/L. And there is Margin Level which determines if you’re eligible to take new positions.
Now, if you’re going in a loss to the extent that the Margin Level falls to 100%, you will receive a Margin Call from the broker. And if the loss gets bigger and becomes 20%, then the Stop Out will be implemented the broker. That is, all your existing positions will be automatically closed, and you won’t be able to take any more new positions.
Let’s say you have $2,000 in your account and you went long on a trade which has used $400 from your account. Also, assume that the broker has set the Stop Out Level at 20%.
Now, let us say your trade is running negative $920. From this Floating Loss, the Equity can be calculated as,
Equity = Balance + Floating P/L
= $1,000 + (-$920)
Equity = $80
Also, the Margin Level will be equal to
Margin Level = (Equity / Used Margin) x 100%
= ($80 / $400) x 100%
Margin Level = 20%
Now since the Margin Level hits the 20% mark, all your positions will be liquidated. And once these positions are closed automatically, the Used Margin will be released and will become your updated Free Margin. That is, your new account balance will be $80. And this Free Margin will be same as the Equity because there are no trades open.
This feature of Stop Out/Stop Out Level is crafted by the brokers to avoid your account balance to go in the negative.
Therefore, this completes the lesson on the Stop Out Level and also all the terminologies involved in a Margin Account. Now, in the coming articles, let us put it all together by considering the different trading scenarios.
But before that, try answering the questions below and check how many of them did you get it right.
Once the price reaches the Stop Out Level, you are forced to close your positions by yourself.
Stop Out Level depends on the?
Stop Out Level is basically used to avoid the balance going in the negative.
Consider the following values: Used Margin = $200 Balance = $1,000 Floating P/L = - $960 Now if the Stop Out Level is 20%, will you be able to open new positions?