Margin Trading Explained

Margin explained

 

Margin trading is the practice of buying or selling financial instruments on a leveraged basis, which enables clients to open positions by depositing less funds than would be required if trading with a traditional broker.

For example, if you were going to buy £100,000 worth of physical shares then the initial outlay would be £100,000 of your capital, up front. In comparison, had you taken the equivalent position with a spread bet, then you would only need to deposit £10,000 as margin, (assuming the margin level for the trade was 10%). Margin varies depending on the product you bet on. An important part of understanding how spread betting works is getting to grips with margin requirements.

Given the nature of this product, trading can result in profits or losses that are significantly greater than the initial deposit.

So what is margin?

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Margin is the initial cash deposit that is required for an investor to be able to enter into a position. This is often referred to as “Deposit Required”.

Margin requirements are set at product level and reflect type of asset, the liquidity and volatility of the underlying instrument.

For example, in shares, ‘blue chip’ companies like Vodafone and BP carry the lowest margin requirement, typically between five and ten per cent, because they are less likely to suffer large daily price movements due to the very high volume of shares that would need to be traded in order for there to be such a sharp fall (or rise) in price. In contrast, smaller companies, with fewer market participants and less shares in issue, are more susceptible to large price movements and even carry a greater likelihood of default. In order to protect against this risk, these shares carry a higher levels of margin requirement, typically between ten and thirty per cent.

Indices and foreign exchange have much lower margin requirements - and therefore higher gearing – as they are based upon a group of underlying shares (or countries) and therefore offer much lower price volatility. This results in their average daily movement typically being less than one per cent, with the maximum daily movement typically less than five per cent.

Account Maintenance: Avoiding A Margin Call

The initial deposit is, in effect, all that is required to fund the position. It is segregated from the total funds in your account as ‘allocated margin’. As open positions go in to profit then the funds in your account balance will increase. However, if the open positions generate losses, then your account balance will decrease. If the total funds fall below the amount allocated as margin then you will either need to remit further funds to maintain the open position(s), or close the position(s).

This situation is known as being on ‘Margin Call’ and should be avoided. Being on ‘Margin Call’ means you do not have sufficient funds in your account to support your current positions. You will be able to monitor this information from the “Account Summary” tab on the trading platform.

In this tab, the ‘% Positions are Funded’ will indicate your level of funding. For example, if the percentage is below 100% you are on margin call.

Orders Aware Margining:

If you place a stop loss order on an open position this may result in a reduced initial margin requirement. Margin is set based on the distance between the current trading price and the level of the stop loss. If the stop loss is not guaranteed then an additional slippage factor of 20% of the full margin is added to calculate the charged initial margin. Please note, if the market price ‘gaps through’ the price at which your non-guaranteed stop loss order is placed, then it will be filled on the next available price. This is called slippage. Please refer to the section Risk Management Tools for further information on this.

Stocks are often traded on a percentage margin, other instruments are on a fixed multiple (please refer to market information sheets for more details)

Example:

Buy £10 per point Wall Street September contract at 10500

Initial Margin Requirement without stop loss is 80 times the stake = £800

Non-guaranteed stop loss placed at 10460.

Initial margin requirement

= 10500 – 10460

= 40 x £10

= £400

+ 20% slippage (80 x 20%)

= 16 x £10

= £160

Total initial margin requirement

= £560

Always be in control of your market risk exposure. Remember that you can reduce your market risk exposure by using stop-loss. Therefore, always use stop losses whenever possible and do not take on bigger positions than you can afford if the market goes against you. That way you can make use of all the benefits of trading with leverage and significantly increase your chances of profit.

 

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