To increase the buying power of the investor, trading on margin is used. It only requires an investor to place a fraction of the funds that are normally needed to open a bigger position. In other words, instead of paying the full value of the position, the investor only needs to pay a percentage of it. This is called an “initial margin”.
It can be beneficial for a retail client to trade in the margin but also a high risk since it has the potential to lose the entire investment. For professional clients, it can lose more than their deposits and needs to add more funds to conceal their losses. Shortly, the amount of money needed to open a position is called “margin” while the multiple of exposure to equity of an account is called “leverage”. The margin rate requirements determine the amount of margin. Margin rate requirements differ in every trading instrument, based on market volatility and liquidity of the primary market.
The potential percentage move of a market in a certain market is called “market volatility”. Volatility is also often linked to liquidity. For instance, the trade of major forex markets such as the US Dollar, British Pound, Euro and Japanese yen is trillions per day which are considered very liquid.
Every broker has different leverage ratio and margin requirements. The amounts usually offered are 200:1, 100:1 and 50:1. Depending on the trade size of the position, the leverage also varies. The leverage of 200:1 is equal to the minimum margin requirement of 0.5% and the leverage of 100:1 is equal to 1%.
Take note that it is important to understand the concept of margin and leverage if you are a beginner in leverage trading. It is advisable to have the risk-free environment to practice trading.
Initial Margin and Margin Requirement
The initial amount placed to open a position is called “initial margin”. It is also known as “initial deposit”. For each market, initial margin requirements will differ as well as depending on the asset type, trading instrument, and the planned trade size of the position.
Trade A put a $2,000 worth of CFD trade in which has an initial margin rate of 0.5%. Thus, Trader A only needs to deposit 0.5% of the total value of the position or $10.
A margin call is when the account is at risk of stop-out and it is forbidden to take on any more risk.
A margin call happens when the equity (balance + unrealized profit and loss) is equal to the margin requirement. The stop-out level is when the equity is equivalent to half of the required margin and the biggest losing position will be forcibly close. So, if the trader opens losing positions and does not have enough equity to keep these positions, the account is at risk of stop-out. Shortly, the trading platform will automatically close any or all the open positions if the balance falls below the margin stop-out level. Per account, the 90% margin close out rule is applied.
Trader B has six open trades in which requires $200 worth of position margin. The current close-out percentage level on the trading account is 90%. With this, the total position margin requirement is $1200. In an event that the total margin requirement falls below 90%, some or all those trades will automatically close out. This is a potential loss to Trader B.
Two Options if on Margin Call
1.Close the position.
2.Deposit additional funds to increase the equity above the margin requirement and to support any further losses. If possible, reduce the size of other positions to add funds to equity.
Leverage trading and margin trading has a lot of advantages, but beginners should know more about these before applying them in trades.