Learn More About Contract For Difference Margin Types

Posted on June 30, 2010
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CFD Margin requirements
An initial margin amount is needed to open a CFD position, either long or short. There are two kinds of margins that are applied to the full value of a Contract for difference position. These are initial margin and variation margin.

Initial Margin
Initial Margin is the initial deposit needed to open a position. For Australian equity Contracts for difference, this ranges from between 5% to 50% of the total notional value of the trade. Therefore, if you bought 10,000 XYZ CFDs at $1.35, you’d be required to have at the 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 can even be as little as 1%.

Variation Margin
Variation Margin is the difference between the initial margin and the margin needed to maintain the position open as the position value changes. As an example, 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 would 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 still hold 2,000 XYZ contracts at $5.40 you have got a margin requirement of $1,080 (i.e. 2000 x 5.40 x 10%). However , there is now a paper loss of $400 also, 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 called a shortage in equity. If you cannot maintain your margin requirement you won’t be able to increase 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The equity (or balance) of your account will fluctuate in line with the money you have deposited or withdrawn out of your account, the profits or losses within your account and the size of the positions held. Throughout 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 current positions, and potential new positions you may wish to take. Your cash balance is used to ascertain if there’s a necessity for extra margin deposits on your account. Once a CFD 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 satisfactorily margined at all times, especially throughout volatile trading periods. You will only be allowed to trade and maintain open positions on the premise of cleared funds within your account, not on promised funds or money in transit as a result you ought to allow enough time for funds to clear when depositing money into your account.

If a position goes into profit, the rise in the equity of your account makes it possible 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 a number of of your open position(s), to cut back your initial margin to the required level; and/or
ii. add more money to your account to maintain the initial margin.
This is the initial trigger level for margin, known as the ‘Margin Call’, which you are required to 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 plus the associated leverage can be very useful if you utilize it correctly. It can also be devastating to the inexperienced trader who has little understanding of the hazards of using leverage and not using a defined risk management plan. There are several ways of using the leverage available by trading Contracts for difference, from the most conservative to one of the most aggressive. The way you utilize leverage will depend upon your personal circumstances.

Before trading CFDs you should read the Product Disclosure Statement (PDS) your CFD provider issues as this will explain in detail how your CFD broker deals with margin. You must also read this free guide to CFD trading, which explains leverage and margin in detail.

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