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Learn about CFD Margin Calculations

By: Ben McGrath

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CFD Margin requirements
An initial margin amount is required to open a Contract for difference position, either long or short. There are a couple of sorts of margins that are applied to the full value of a CFD position. They are initial margin and variation margin.

Initial Margin
Initial Margin is the initial deposit required to open a position. For Australian equity CFDs, this ranges from between 5% to 50% of the entire notional value of the trade. Hence, if you purchased 10,000 XYZ CFDs at $1.35, you'd be required to have at least $1,350 within your account to cover the minimum margin requirement (10% of your total position size of $13,500). The margin requirement for index and foreign exchange CFDs is often as little as 1%.

Variation Margin
Variation Margin relates to the difference between the initial margin and the margin required to maintain the position open as the position value changes. To illustrate if bought 2,000 XYZ CFDs, at $5.60 it will give you a position value of 2,000 x $5.60 = $11,200. Assuming XYZ is margined at 10% you would want no less than $1,120 initial margin to open this position. If XYZ falls to say, $5.40, you will now have a loss of $400 ($0.20 x 2,000). This loss (often 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 will have a margin requirement of $1,080 (i.e. 2000 x 5.40 x 10%). There's now a paper loss of $400 also, the initial margin has been reduced to $720. This is exactly $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 cannot sustain your margin requirement you will be unable to extend your position however you'll always have the ability to reduce or close a position.

Equity Balances
The equity (or balance) of your account will fluctuate based on the cash you've deposited or withdrawn out of your account, the profits or losses within your account and the size of the positions held.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. Consequently your equity balance is constantly 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 assess your available margin against existing positions, and possible new positions you may need to take. Your cash balance is used to ascertain if there is a necessity for additional margin deposits in your account. Once a Contract for difference trade is opened, variation margin requirement must always be maintained for your open positions. It is your duty to make sure that your account is adequately 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 funds or funds in transit therefore it's essential to allow enough time for funds to clear when depositing cash into your account.

If a position turns into profit, the increase in the equity of your account allows for further positions to be opened.

Shortage in Equity
A shortage in equity occurs when the account balance falls below the specified initial margin. Accounts with a shortage in equity are usually only allowed to scale back 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 a number of of your open position(s), to cut back your initial margin to the specified level; and/or
ii. add more money to your account to maintain the initial margin.
This is the initial trigger level for margin, referred to as the 'Margin Call', which you must add additional funds to keep your open positions.

Stop Out Level
You will be at risk that your open positions will generally be closed whenever you have less than 40% of your required initial margin (i.e. 40% of your 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 strategy. 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 utilize leverage will depend upon your individual circumstances.

Before trading Contracts for difference it is advisable to read the Product Disclosure Statement (PDS) that your CFD broker issues as this will explain in detail how your CFD provider deals with margin.

Article Source: http://depositarticles.com/

The author Ben McGrath is a professional Contract for difference trader. He deals with Australia's most popular CFD provider IC Markets. Ben has published a number of books and guides on CFDs, you can download and read his most recent guide to CFD trading and understand more about CFD margining for free.

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