What Does Stop-Out Level Mean In Trading

How Stop-Out Levels Work

Key Takeaways From What Does Stop-Out Level Mean In Trading

What Does Stop-Out Level Mean In Trading

Written by:

Nika

Edited by:

Armand van Aswegen

Written on:

21 February 2024

Last edit:

21 February 2024

Thousands of traders buy and sell securities using leverage, which allows them to increase their buying power and boost potential profits.

However, margin trading also carries significant risk, as borrowed shares must eventually be returned to the broker.

For this reason, brokerages have initial margin requirements that determine the level at which the account balance must be maintained in order to ensure the final payment to the broker.

This threshold is called the ‘stop-out’ level and is a predetermined margin level at which a broker will automatically close a trader's open positions in order to prevent further losses.

The stop-out level is a risk management mechanism implemented by brokers to protect both traders and themselves from excessive losses.

The stop-out level is typically expressed as a percentage, representing the minimum margin level required to keep a position open.

If a trader's account falls below this level due to losses incurred in open positions, the broker will initiate a margin call and may automatically close out the trader's positions.

As mentioned above, the stop-out level is expressed as a percentage that shows the minimum margin requirement in order to maintain an open position.

This margin requirement varies between brokerages, based on their financial position and the degree of freedom allowed to traders.

For example, if the stop-out level is set at 20%, it means that if the equity in a trader's account falls below 20% of the required margin, the broker may start closing out positions to prevent the account from going into negative territory.

Stop-out levels are designed to ensure that traders maintain a sufficient amount of funds in their accounts to cover potential losses and avoid situations where losses exceed the available margin, leading to debts or negative balances.

To better understand how stop-out levels work, let’s look at a breakdown of the process step-by-step:

Setting the Stop-Out Level

Brokers specify a stop-out level, which is usually expressed as a percentage of the margin required to maintain open positions. This may range from broker to broker, depending on the policy on margin trading. Common stop-out levels range from 10% to 50%.

Traders can view the margin requirements as they are placing a trade on margin, which gives them the opportunity to decide whether the margin requirements upheld by the broker are convenient for them.

Margin Call

If the equity in a trader's account falls below a certain threshold, typically the margin required to maintain open positions, the broker issues a margin call. This is a warning to the trader that their account is at risk of falling below the stop-out level.

If the trader fails to meet the margin requirements in time, the brokerage may resort to liquidating existing positions to repay the amount owed.

Automatic Position Closure

If the trader does not take action to address the margin call and the equity continues to decline, reaching the stop-out level, the broker may automatically close out some or all of the trader's open positions.

This is done to prevent further losses and to ensure that the trader does not end up owing more money than they have in their account.

Preventing negative account balances is one of the most important risk management measures upheld by brokerages and financial regulators.

The primary goal of the stop-out level is to prevent accounts from going into negative balances. Closing out positions at the stop-out level helps protect both the trader and the broker from the accumulation of excessive losses.

A stop-out level is set by a brokerage at which the account balance of a trader is automatically liquidated
Stop-out levels are used to deter margin traders from having negative balances, which is a risk management measure enforced to protect both parties
Stop-out levels vary between brokerages and are typically between 10-50%, based on company policy
Stop-outs are typically expressed as a percentage as the minimum margin required to maintain open positions on the account

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FAQ On Stop-Out Level

How does a stop-out level work?

A stop-out level in trading is a predefined margin percentage. If a trader's account equity falls below this level due to losses, the broker automatically closes open positions to prevent further losses and negative balances, safeguarding both the trader and broker from excessive risk.

What happens when a stop-out level is reached?

When a stop-out level is reached, a broker automatically closes a trader's open positions to prevent further losses. This risk management measure ensures that the account doesn't go into negative balance, protecting both the trader and the broker.

What is the example of a stop-out?

For instance, if a trader's stop-out level is set at 20%, and their account equity falls below 20% of the required margin due to losses, the broker will automatically close out their positions to prevent additional losses and potential negative balances.