In online trading, the concepts of initial margin and maintenance margin are very important. We already mentioned these two concepts in the lesson on trading platforms, but here we will explain them in more detail as to what they consist of and why they should always be taken into consideration.
To better understand the content of this lesson, we recommend you access a demo platform in order to personally view the items of the platform that we are discussing. For example, you can access the Plus500 demo platform, or the 24option demo platform.
The initial margin, in CFD trading, is the amount of capital actually required by the trader to open a position. For example, if the leverage is 1:30 and you want to trade on a value of €10,000, the required margin will be €333.
The required margin is then calculated using this formula:
nominal capital / leverage
It should be noted that the required margin consists of two parts: the initial margin and the maintenance margin. Below we’ll explore them in detail.
The initial margin is the part of the margin on which the price changes take effect and on which profits and losses are produced.
In practice, once a position is opened, price changes on the market affect the invested capital and more precisely the initial margin.
Unlike the initial margin, the maintenance margin serves, as the name implies, to maintain an open position. In fact, to keep a new position open, it is necessary to make sure that the equity (i.e. the net capital) is higher than a certain percentage level of the maintenance margin. Maintenance margin level requirements are different and specific to each financial instrument, so, for each selected instrument, a different maintenance margin may apply (which you can check in the “details” section). The maintenance margin is always monitored in real time and once this required margin exceeds a certain percentage (for Plus500 40% of the equity), a warning email is sent out.
We have just seen that if the maintenance margin exceeds a certain percentage of the equity, the broker sends a warning email to the investor. This is referred to as a Margin Call. This serves to request the investor restore the level of equity or to warn of liquidating a position in order to balance the situation.
Now let’s see an example of how a margin call option can be put into practice:
Let’s suppose the initial registration was completed and 600 euro was deposited via Postepay.
Balance: €600 (Deposits – withdrawals + economic account of closed positions)
Balance available: €600 (balance + statement of open positions – initial margins)
Income Statement: $0 (total profits and losses of all open positions including daily premiums)
Equity: €600 (balance + statement of open positions)
Suppose that at 10:30 we buy 10 Google shares (CFD) for €500
The total amount purchased is: 10 * €500 = €5000
The initial margin required for 10 Google shares is 10%: €500
The maintenance margin needed to maintain 10 Google shares is 5%: €250
If the equity falls below €250, a margin call option will be activated. Plus500 will liquidate open positions.
The available balance following the purchase of Google shares is: €100 (€600 – 10% * €5000)
Income statement: €0
Equity: €600 (€600 + €0)
11:15 – suppose that Google shares go down to €480
Balance available: €0 [€600 – 10% * €5000 + 10*(€480 – €500)] Income statement = -€200 (10 * €480 – 10 * €500)
The Equity will be €400 or (-€200 + €600)
13:00 – suppose that Google shares go down to €450. A margin call option is activated and Plus500 clears the position.
Balance: € 600
Balance available: €0 [€600 – 10% * €5000 + 10 * (€450 – €500)] Income statement = – €500 (10*€450 – 10*€500)
Equity: €100 (€-500 + €600)
The reason a margin call option is activated is because the equity is €100 while a minimum of €250 is required (i.e., 5% of €500 x 10 shares = 5% on €5000 = €250) to keep a position open on 10 Google shares. Therefore Plus500 will liquidate the position.
The current balance is:
Balance: €100 (the balance changes only when you close a position or withdraw money).
Balance available: €100 (Deposits – withdrawals + statement of closed positions)
Income statement = €0 (no open position)
Equity: €100 (balance + statement of open positions)
Go to lesson 4a – Stop Loss, what they are, how to use them