The Stop Out Level is a critical concept in leveraged trading, particularly in forex and CFD markets. It refers to a predefined margin threshold set by the broker, at which your open positions are automatically closed to prevent your account from going into a negative balance. This mechanism ensures you don't lose more money than you have in your account, protecting both you (the trader) and the broker.
The Stop Out Level is based on the margin level, which is calculated as:
Margin Level = (Equity / Used Margin) * 100%
Equity: The total value of your account, including your initial deposit and any profits or losses from open trades.
Used Margin: The amount of money tied up in your open trades.
When your open positions lose value (floating losses), your account equity decreases. As your equity decreases, the margin level declines. If it reaches the stop out level, the broker’s system will automatically close your trades, starting with the most losing position.
This is done to free up margin and prevent your account from going into negative equity.
Protection Against Negative Balance: It prevents your account from going into debt if the market moves sharply against you.
Risk Management for Brokers: Brokers use the stop out level to avoid the risk of clients owing more than their deposit.
Traders' Last Line of Defense: While it may seem inconvenient, the stop out level helps traders avoid losing more than their initial deposit and can save them from making poor decisions under pressure.
Let’s consider an example:
Initial Deposit (Account Balance): $1,000
Broker’s Stop Out Level: 30%
Used Margin: $200
Margin Level: (1,000 / 200) * 100% = 500% (healthy account)
The market moves unfavorably, and your open positions start losing value.
Floating Loss: $940 (the amount the position is losing)
New Equity: $1,000 - $940 = $60
New Margin Level: (60 / 200) * 100% = 30%
At this point, your margin level hits 30%, which is the stop out level set by your broker. The broker’s system will start closing your trades, beginning with the most losing position, to bring your margin level above 30%. If the margin level is still below the stop out level after some positions are closed, more trades will be closed until it is above the threshold.
Varying Stop Out Levels: Different brokers may have different stop out levels, such as 20%, 30%, or 50%. Always check with your broker.
Margin Call vs. Stop Out: A margin call is a warning that your margin is low, and you may need to add more funds. The stop out level is an automatic action that closes your trades when your margin level drops too low.
Slippage: In volatile markets, the price at which your positions are closed during a stop out might be different from the theoretical stop out price due to slippage. Brokers typically absorb this risk, but it could result in a small negative balance in extreme cases.
Risk Management: The stop out level should not be relied upon as your only risk management tool. Always use stop-loss orders and manage your position sizes to avoid reaching the stop out level in the first place.