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 trading 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 required 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:
Total Value / 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 required 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, 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 500 euro was deposited via credit card. At the start, on the platform we would have:
- Available Balance: €500 (amout available, that can be used as Initial Margin = Balance plus the P&L of all your open positions minus the Initial Margins)
- Equity: €500 (the current account evaluation. Balance + the total profit/loss (P&L) from all the currently open positions).
- Maintenance Margin: €0 (requested margin to keep a position open). On Plus500, this is the half of the required margin.
- Profit/Loss: €0 (the profit and loss for all open positions)
Let’s suppose that at 10:30 we buy 1 Amazon share (CFD) quoted €2,000. The total value of these shares is: 1 * €2,000 = €2,000. The required margin for these shares is 20% of €2,000, so €400. The required margin is what you have to invest to open a position. The maintenance margin needed to maintain 10 these shares is 10% of €2,000, so €200 (which is the 50% of the required margin).
Just after the “buy” trade opening, the platform will show this data:
- Available balance: (€500 – €400) – spread = €100 – spread
- Equity: €500 – spread
- Maintenance Margin: €200 (the maintenance margin doesn’t change)
- P/L: €0 – spread
Note: when you open the position, the spread is deducted. So, even if the price hasn’t changed, the spread will be calculated and deducted from the available balance.
Now, remember: If the equity falls below a certain percentage of the equity, a margin call option will be activated. If you keep the position open, and it continues to lose, the broker will liquidate the position (the broker will close the position). Let’s continue with the example.
11:15 – Let’s suppose that the shares value go down to €1950 (loss of 2.5%). This 2.5% will be calculated on the total value amount (which was 2000). So, 2.5% of 2000 is €50. Now, we have to subtract €50. Let’s see the economic account details now:
- Available Balance: €50 – spread. How we calculate it: Initial capital €500 – spread – (€200 that is the maintenance margin) – (200€ that is the initial margin) – (2.5% of the total value amount) = €50 – spread
- Equity: €450 – spread. How we calculate it: Available balance €50 + maintenance margin 200€ + initial margin €200 – spread.
- Maintenance margin: 200€
- P/L : – €50 – spread
As you can see, the equity says how much you have considering profit/loss and margins.
Now, let’s say that the price continues to fall down. IF the equity falls below the maintenance margin, a margin call will be executed.
After the margin call you can:
- Let the position open and see what happens (closed by the broker if it continues to fall, or a positive recover)
- Add capital
- Close the position personally.
Go to lesson 4a – Stop Loss, what they are, how to use them