Find out about CFD Margin Calculations (aspen publishing)
No commentsBy Ben McGrath
CFD Margin requirements
An initial margin amount is needed to open a CFD position, either long or short. There are a couple of kinds of margins which are applied to the full value of a Contract for difference position. They are initial margin and variation margin.
Initial Margin
Initial Margin is the initial deposit needed to open a position. For Australian equity CFDs, this ranges from between 5% to 50% of the whole notional value of the position. Hence, if you purchased 10,000 XYZ CFDs at $1.35, you would be required to have no less than $1,350 within your account to cover the minimum margin prerequisite (10% of the total position size of $13,500). The margin requirement for index and foreign exchange CFDs can even be as low as 1%.
Variation Margin
Variation Margin is the difference between the initial margin and the margin required to keep the position open as the position value changes. For example if bought 2,000 XYZ CFDs, at $5.60 it would give you a position value of 2,000 x $5.60 = $11,200. Assuming XYZ is margined at 10% you would want a minimum $1,120 initial margin to open this position. If XYZ goes down to say, $5.40, you would now have a loss of $400 ($0.20 x 2,000). This loss (generally known as variation margin) is subtracted from your initial margin of $1,120, leaving a deposit of $720. Since you continue to hold 2,000 XYZ contracts at $5.40 you have a margin requirement of $1,080 (i.e. 2000 x 5.40 x 10%). There’s now a paper loss of $400 and the initial margin has been reduced to $720. This is $360 lower than the margin required to hold the position open, which means more margin is necessary to top up the account. The deficit in margin is known as a shortage in equity. If you can not sustain your margin requirement you won’t be able to increase your position however you will always be able to reduce or close a position.
Equity Balances
The equity (or balance) of your account will rise and fall according to the cash you have deposited or withdrawn out of your account, the profits or losses in your account and the size of the positions held. During the trading day your account balance, as well as all open positions, are valued against the prevailing market rate. As a result your equity balance is continually calculated in-line or marked-to-market with market movements. Your end of day account balance is calculated using the mid-closing rates (or the final traded price). The equity balance is used to evaluate your available margin against existing positions, and possible new positions you may wish to take. Your cash balance is used to determine if there is a requirement for additional margin deposits in your account. Once a Contract for difference trade is opened, variation margin requirement should always be maintained for your open positions. It is your duty to make sure that your account is sufficiently margined always, especially during volatile trading periods. You’ll only be allowed to buy and sell and maintain open positions on the basis of cleared funds within your account, not on promised money or funds in transit as a result you have to allow enough time for money to clear when depositing cash into your account.
If a position goes into profit, the rise in the equity of your account allows for for further positions to be opened.
Shortage in Equity
A shortage in equity takes place when the account balance falls below the required initial margin. Accounts having a shortage in equity are usually only allowed to reduce open positions, until the equity balance is in excess of the required deposit. No new positions can be opened until this situation is rectified.
Margin Calls
If ever the market moves against you and your equity balance falls below your initial margin you usually have the option to:
i. close one or more of your open position(s), to reduce your initial margin to the required level; and/or
ii. add more money to your account to maintain the initial margin.
This is the first trigger level for margin, known as the ‘Margin Call’, which you need to add additional funds to keep your open positions.
Stop Out Level
You are at risk that your open positions will generally be closed whenever you have less than 40% of the required initial margin (i.e. 40% of the position size) however this will likely vary between CFD providers.
Margin, leverage and risk
Margin and the associated leverage can be very useful if you utilize it correctly. It can also be devastating to the inexperienced trader that has little understanding of the risks of using leverage with no defined risk management plan. There are several ways of using the leverage available by trading CFDs, from the most conservative to one of the most aggressive. The way you use leverage will depend upon your personal circumstances.
Before trading CFDs you must read the Product Disclosure Statement (PDS) that your CFD broker issues as this will explain in detail how your Contract for difference broker deals with margin.
The author Ben McGrath is a professional Contract for difference trader. He trades with Australia’s most popular CFD provider IC Markets. Ben has published a number of books and guides on CFDs, you can download his most recent guide to CFD trading and understand more about CFD margining for free.
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Saturday, June 26th, 2010 at 5:30 pm and is filed under education. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
