Margin

Margin is the amount a trader has to deposit with the broker or issuer as collateral. It is an integral part of every transaction involving leveraged products such as CFDs, futures or leveraged forex trading: the trader only puts up a fraction of the position's value but trades the full position. A required minimum amount must also be available in the account before the trader can open positions at all.

Margin and leverage

The lower the margin requirement, the higher the leverage. A margin requirement of 5%, for example, corresponds to leverage of 20:1: with $1,000 of margin, a position worth $20,000 can be opened. The part of the account equity that is not tied up as margin is called free margin; it is available for new positions and for absorbing paper losses.

Margin call and stop-out

If the trader can no longer cover the margin required for the open positions, a margin call occurs: the trader is asked to deposit additional funds and, if necessary, to close positions. If the account equity keeps falling and reaches the stop-out level set by the broker, open positions are closed automatically to prevent further losses.

Example: a trader has $2,000 in the account and opens the $20,000 position described above, using $1,000 as margin. If the position shows a loss of $1,000, the equity falls to $1,000 – exactly the margin required. Any further loss can now lead to a margin call and, ultimately, a stop-out.

The risk of leverage

Leverage works in both directions. Profits and losses are calculated on the full position size, not on the margin deposited. In the example, a price move of just 5% against the position causes a loss of $1,000 – the entire margin. Depending on the regulation and the account type, losses can even exceed the funds in the account. Careful use of leverage, stop-losses and appropriate position sizes are therefore a central part of risk management.