Contract for difference Margin requirements
An initial margin amount is needed to open a Contract for difference position, either long or short. There are two sorts of margins which are applied to the total 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 full notional value of the position. For this reason, if you bought 10,000 XYZ CFDs at $1.35, you’d 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 prerequisite for index and foreign exchange CFDs can be as little as 1%.
Variation Margin
Variation Margin relates to the difference between the initial margin and the margin needed to keep the position open as the position value changes. As an 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 need at the very least $1,120 initial margin to open this position. If XYZ goes down to say, $5.40, you will 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 still 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 is now a paper loss of $400 also, the initial margin has been reduced to $720. This is exactly $360 less than the margin required to maintain the position open, which means more margin is needed 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 not be able to extend your position however you will always have the ability to reduce or close a position.
Equity Balances
The equity (or balance) of your account will vary in line with the cash you’ve deposited or withdrawn out of your account, the profits or losses in your account and the size of the positions held. Throughout the trading day your account balance, together with all open positions, are valued against the current 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 assess your available margin against current positions, and possible new positions you may need to take. Your cash balance is used to determine if there is a requirement for added margin deposits in your account. Once a CFD trade is opened, variation margin requirement must always be maintained on your open positions. It is your responsibility to make sure that your account is adequately margined always, especially throughout volatile trading periods. You will only be allowed to trade and maintain open positions on the basis of cleared funds in your account, not on promised funds or funds in transit as a result you must permit sufficient time for money to clear when depositing cash into your account.
If a position goes into profit, the increase in the equity of your account allows 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 with a shortage in equity are generally only allowed to scale back open positions, until the equity balance is in excess of the specified 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 choice of:
i. close one or more of your open position(s), to reduce your initial margin to the specified 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 are required to add additional funds to keep your open positions.
Stop Out Level
You are in danger that your open positions will generally be closed when you have less than 40% of the required initial margin (i.e. 40% of your position size) however this will vary between CFD providers.
Margin, leverage and risk
Margin and the associated leverage can be very useful if you use 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 strategy. There are many ways of using the leverage available by trading Contracts for difference, from the most conservative to one of the most aggressive. The way in which you employ leverage will depend on your own circumstances.
Prior to trading CFDs make sure you read the Product Disclosure Statement (PDS) that your CFD broker issues as this will explain in detail how your Contract for difference provider deals with margin. You must also read this free guide to CFD investing, which explains leverage and margin in detail.
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