Short Description: A spread better will require an initial margin requirement to cover a certain percentage of the price of a security. For a futures contract, the initial margin is set by the exchange. Placing a stop loss can reduce the initial margin requirement on a trade.
What is an Initial Margin Requirement?
With the advance of technology, the retail trading industry is offering many lucrative opportunities for retail traders who want to get their feet wet in trading the financial markets. If you’re new to the trading business, you may feel overwhelmed by the seemingly complicated terms and concepts that make up the basics of successful trading. One of those concepts which may sound complicated at first is margin trading, but we’ll provide a simple explanation of what margin trading is and how you can take full advantage of it.
What Does Trading on Margin Mean?
Trading on margin allows traders to open a much larger position than their trading account size would otherwise allow. When opening a trade on margin, your broker lends you a certain sum of money to increase your total market exposure and magnify your potential profits (and losses) even on small differences between the sell price and purchase price.
To do so, a part of your trading account is allocated as a collateral for the trade, called the initial margin requirement. After you open your leveraged trade, the initial margin requirement is automatically deposited back to your trading account, together with any realised profits or losses on the trade.
Margin and Leverage: What’s the Difference?
The concepts of margin and leverage are interconnected. The amount of leverage that a broker offers determines the required initial margin that you need to allocate on your trading account.
Let’s use an example:
A leverage of 100:1, which is often offered on currency pairs, allows you to open a position size that is up to 100 times larger than the total value of your trading account! However, this approach would allocate your entire trading account as the collateral for the trade, which could quickly lead to a margin call.
Initial Margin Requirement Calculations
Initial margin requirements are determined by the amount of leverage that your broker offers. A leverage of 100:1 requires a minimum margin of 1% of the total position size.
Let’s use another example:
If you have a $10,000 trading account, you could theoretically open a position size worth $1,000,000 with your total account size allocated as the margin for the trade (1% of $1,000,000). Similarly, opening a position size worth $50,000 would require a margin of only $500 from your $10,000 trading account.
The following table shows the initial margin requirements required on a margin account, depending on the amount of leverage that your broker offers:
Maintenance Margin Requirements
If you open a leveraged trade, you need to pay attention to your maintenance margin requirements in order to prevent a margin call. Basically, if the market value of trading account falls below the maintenance margin requirements set by your broker, you’ll receive a margin call and your broker will automatically close all your open positions.
To prevent a margin call, follow the level at which your stocks are priced at and always use stop-loss levels to preserve your trading capital. This is especially important during important market events, such as changes in the monetary policy made by the Federal Reserve Board.
Read: Learn more about margins
When trading on margin, traders borrow a certain sum of money from brokerage firms by allocating a part of their trading account as the collateral for the trades. While margin trading is very popular on the Forex market, traders can also increase their exposure to futures contracts or on the stock market by using leverage.
When you buy on margin, pay attention to the maintenance requirement by ensuring that your account always has enough free margin to withstand negative price fluctuations. Your free margin is simply the difference between your maintenance margin requirements and your total trading account size.