In online trading, the concepts of initial margin, maintenance margin and margin call are very important. We have mentioned these elements on the trading platform lesson, but here we will explain in detail what they are and why they should always be considered.
To better understand the content of this lesson, we recommend that you access a demo platform to personally view the elements on the platform we will be discussing. For example, you can access the IQ Option demo platform, or you can access eToro.
Margin Requirement
The margin requirement in CFD trading is the amount of capital actually required from the trader to open a position. For example, if the leverage is 1:30 and you want to trade in a value of $10,000, the required margin will be equal to $333.
We calculate the margin requirement using this formula:
NOMINAL CAPITAL / FINANCIAL LEVERAGE
Please note that the margin requirement consists of two parts: the initial margin and the maintenance margin. We will discover them in detail below.
Initial margin
The initial margin is the part of the margin on which price changes have an effect and on which profits and losses also occur.
In practice, when a position is opened, price changes in the market affect the invested capital and more precisely the initial margin.
In CFD trading, margin is nothing more than the initial deposit the broker requires to trade. Simply put, the margin is the amount that must be paid into the live account to start trading. To specify what the amount of the requested sum is, it is the broker himself who explains it under the initial deposit element.
Initial Margin or Variable Margin
The margin can be of two different types: initial or variable. With regard to the initial margin, it acquires different values depending on the type of underlying assets on which it is traded. In the case of stocks, the initial margin is in the range of 3 to 30%. As for all other financial instruments, the margin is much lower, between 0.5% and 1%.
Therefore, stock CFDs have a higher initial margin, while Forex, commodities and indices have a smaller initial margin. This large discrepancy between stocks and other financial instruments arises in light of the amount of perceived risk. In short, if the perceived risk is high, then the margin will also be high. Among the various assets, stocks are capable of generating the greatest fluctuations and therefore a possible higher gain, but also a possible higher loss.
Through the initial margin, the broker only activates a kind of self-protection. This objective explains why the initial margin is always due. In fact, without the initial margin, the broker would lose in the event of the trader’s insolvency. The initial margin, therefore, makes it possible to cover the theoretical settlement costs of the trader’s portfolio that would accumulate in the most unfavourable market scenario.
Maintenance margin
Unlike the initial margin, the maintenance margin serves, as its name suggests, to maintain an open position. To keep a new position open, you need to ensure that the equity (or net capital) is a certain percentage higher than the maintenance margin level.
The maintenance margin level is different and specific to each financial instrument. Therefore, for each selected instrument you can apply a different maintenance margin (which you can see in “details”).
Margin Call
We have just seen that, if the maintenance margin exceeds a certain percentage of the equity, the broker would send an email or a warning. This is called a Margin Call. This is used to ask you to restore the level of capital or to warn of a settlement to balance the situation.
Now let’s look at an example of how a margin call can be implemented:
Let’s assume that you completed the registration and deposited $600 via PayPal.
Balance: $600 (Deposits – withdrawals + economic account of closed positions) Available capital: $600 (balance + income statement of open positions – initial margins) Income statement = $0 (total profit and loss of all open positions, including daily funding) Equity: $600 (balance + account of open positions)
10.30 – Suppose we buy 10 Google shares (CFDs) for $500 The total amount purchased is: 10*500 $ = $5000 The initial margin required for 10 Google shares is 10%: $500 The maintenance margin required to hold 10 Google shares is 5%: $250
If the equity falls below $250, a margin call option will be activated. IQ Option will liquidate open positions.
Balance: $600 The Capital available after the purchase of Google shares is: $100 ($600 – 10%*$5000) Income Statement = $0 Capital: $600 ($600 + $0)
11.15 – Suppose Google shares drop to $480
Balance: $600 Available capital: 0$ [600$ – 10%*5000$ + 10*(480$ -500$)] Economic account = -200$ (10*480$ – 10*500$) The capital will be $400 or (-$200 + $600)
13.00 – suppose Google shares drop to $450. A margin call option is activated and IQ Option liquidates the position.
Balance: $600 Available capital: 0$ [600$ – 10%*5000$ + 10*(450$ – 500$)] Income statement = -500$ (10*450$ – 10*500$) Capital: $100 (-$500 + $600)
The reason why a margin call is triggered is because the Equity is $100 while $250 (i.e. 5% of $500 x 10 shares = 5% over $5,000 = $250) is needed to keep a position on 10 Google shares open. Therefore, IQ Option liquidated the position. The current balance is:
Balance: $100 (the balance changes only when you close a position or withdraw money) Available balance: $100 (Deposits – withdrawals + profit and loss statement of closed positions) Income statement = $0 (no open positions) Equity: $100 (balance + income statement of open positions)
Go to Lesson 4a – Stop Loss, what they are and how to use them
Go to Lesson 5 – How CFD Forex Brokers Make Profit
From today, you can start trading CFDs through a demo account with this world leading platform, authorized by CYSEC
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