What is margin?

Trading using broker platforms presents an opportunity to buy and sell positions that are greater in value than the amount of funds you deposit in your trading account. In the simplest example, you deposit $5,000 into your trading account and then buy (or sell) $15,000 of a CFD. The funds deposited, in this case $5,000, is your margin, and the ratio of your deposit to the size of the total holding is called leverage. This is different from a conventional ‘buy and hold’ equity trading account where cash paid into your account must be at least equal in worth to the value of the instrument you are buying. A further thing to note is that conventional accounts, unlike broker platforms, don’t allow you to sell-short in the market. Reviewing a broker comparison site shows that the amount of margin required can vary broker by broker. Individual brokers will also apply different margin rates across different products and markets. That is because the broker platforms factor in the levels of price volatility associated with different types of markets. The greater the risk of a dramatic price change, the more margin will be required to trade, and accordingly less leverage is possible. The below shows a summary margin report on a live Demo account, in this instance using the one provided by www.markets.com. httpssss://demo-trader.markets.com This trader opened the demo account with a balance of £10,000 After opening and closing some trades Realised Profits are £166.43 so the cash balance is £10,166.43 There is an open position currently running and showing an Unrealised Profit of £221.09 The Equity in the account is the sum of cash deposited + realised profits + unrealised profits = £10,387.52 Used Margin = £1,750.81 This figure indicates the sum of the margin currently being used by open positions. It is calculated by adding all of the Initial Margins of the open positions. In this demo account, there is only one open position which is an amount of 5 of the UK100 Futures. A long position, giving the trader exposure to the UK FTSE 100 and with an entry price of 7003.95 Margin is calculated using the formula: Entry price x quantity x leverage = 7003.95 x 5 x 20 = £1,750.81 = the referenced Used Margin number. The ‘real value’ of the position = the current price x quantity. In our example, if the future is trading at 7,046 and we hold 5 the real value = 7,046 x 5 = £35,230. Bringing these things together, after using £1,750.81 as margin to enter the trade and applying a leverage rate of 1:20 the account exposure to the market is £35,230. We mentioned earlier that different broker platforms offer different leverage levels across different markets. The below extract from httpssss://www.markets.com/cfds/ gives an example of the rates across a few instruments. Trades put on instruments in the energy market will have a leverage of 1:10 applied and so would use up the spare margin twice as fast as any further positions in the UK Index. Or to put it another way, following a deposit of £10,000 the account has put on a position equating to about £35,000 and still has spare capacity to put on more trades as the Free Margin is £8,636.70. The way that leverage and margin allow exposure to the market which is much greater than the initial funds deposited must be considered when trading because profits and losses can be considerable in relation to applied funds.