What is Stop Out?
The term Stop Out in trading refers to the automatic closing of positions by a broker when the trader’s margin level falls below a predetermined threshold. It acts as a safety mechanism to minimize the risk of further losses and to protect both the trader and the broker.
When a trader uses leverage to open positions, they are essentially borrowing money from the broker. If the market moves against the trader’s position, the broker may execute a stop-out to liquidate positions, ensuring that the trader doesn’t lose more than their initial margin or deposit.
A trader has an initial margin deposit of $1,000 and uses 10:1 leverage to enter into a trade worth $10,000. The broker’s stop-out level is 20%. If the trader incurs losses such that only 20% of the margin ($200) is left to maintain the open position, the broker will automatically close the trade to prevent further loss.
This automatic action aims to limit the losses to the amount of money the trader has in their margin account and prevents them from going into debt with the broker.
Stop out vs. Stopped out
Make sure not to confuse this term with the term Stopped out.
These terms are different but closely related. Stopped out refers to the act of being forced to exit a position due to a stop-loss order being triggered. While Stop out is an automatic process that by the broker initiates to close positions when a trader’s margin level falls below a predetermined threshold, Stopped Out usually occurs at the moment of execution of a SL order that the trader has set.
A trader buys a stock at $100 per share and sets a stop-loss order at $90. If the stock price falls to $90 or below, the SL order would trigger, and the trader would exit the position by selling the stock at the prevailing market price near $90.
Both Stop Out and Stopped Out limit losses. However, a broker initiates Stop Out, typically in relation to leveraged trading with margin accounts, whereas a trader initiates Stopped Out, which can apply to any type of trading, whether leveraged or not.