What is Margin?

When trading financial markets certain key terms are essential to understand. One of these is 'margin'. By grasping the concept of margin traders can utilise new strategies and techniques. Equally, awareness of the risks of margin trading and helps traders avoid potential pitfalls.

In finance and trading, margin refers to the borrowed funds used by a trader to purchase securities, such as stocks or bonds. Margin allows traders to increase their buying power and amplify their trading outcomes. A trader will be required to keep a certain amount of equity within the account as collateral in order to keep a trade using loans active. This is because when you trade with a margin, losses are potentially limitless. As opposed to a conventional trade where your account balance can only fall to 0, with a margin you can create debt for yourself if your position moves against you.

This article will cover other aspects of margin comprehensively. Including margin trading, initial margin, margin calls, margin levels, and best practice when trading on margin. Traders are advised to be aware that trading on margin is a high-risk activity. This article is purely educational, allowing for more informed and strategic decision-making processes.

What is an Initial Margin?

An initial margin is like a security deposit that a person or company must put down when they enter into a leveraged trade, such as trading futures contracts or Contracts for Difference (CFDs). These financial products are called derivatives. This deposit (or margin) is a percentage of the total value of the transaction. It is used to protect both parties involved in the trade from potential losses if the market moves against them or if one party can't fulfil their obligations.

The organization managing the transaction, such as trading exchange markets.com, sets the amount of the Initial Margin. They do this by considering how risky they deem the financial product to be and how much they estimate the volatility of its value change might be. By requiring a margin, the trader is demonstrating that they have the funds to cover any potential losses if the trade moves against them.

To make sure the Initial Margin remains enough to cover possible losses, these deposits are regularly checked and adjusted. If the market changes significantly, the amount of the initial margin may be increased or decreased accordingly. This ongoing monitoring helps to minimize the risk of one party defaulting on their financial obligations and causing losses for the other party. These calculations allow the broker to calculate a ‘maintenance margin’ on the trade; usually about 50-70% of the initial margin that must be kept in the account to keep the trade active. If losses on the trade exceed the maintenance margin this will typically result in a ‘margin call’.

What is a Margin Call?

As explained briefly above, a trader must maintain a certain level of funds in their account to keep a leveraged position open (maintenance margin). A margin call is when a brokerage firm asks a trader to put more money or securities into their account because the value of their positions have dropped below the maintenance margin.

If the trader does not deposit more funds into the account, the broker can sell their positions without asking for permission. This is known as ‘forced sale’ or ‘forced liquidation’ and allows the sale of any open positions by your brokerage firm to bring the account value back up to the minimum level. Your brokerage firm can decide which positions to liquidate and may even charge you a commission for the transactions or interest on the borrowed funds. However, at markets.com you can be safe in the knowledge that even when you take a risk trading on margin, you will never be charged interest or commissions on a margin call.

Conclusion

Margin trading can be a powerful tool for traders seeking to amplify their trading outcomes, but it also carries significant risks. Understanding key concepts such as initial margin, margin call, and margin level is crucial for traders to navigate the world of margin trading effectively. By being aware of the potential pitfalls and requirements of trading on margin, traders can make more informed decisions and develop strategic approaches to manage their positions. It is important to note that margin trading is a high-risk activity and should be undertaken with caution. As always, this article is for educational purposes only and traders should seek professional advice before engaging in any trading activities.