Orders Aware Margining and Margin Calls
Many traders use a lot of leverage, and so run the risk of losing more money than they have in their account. If this happens, your account can have a negative balance, often called a “debit balance”. In this case, you will owe money to your broker, and the broker may call in collections agencies or engage in legal action to recover the money you owe it.
Order Aware Margining
Placing a stop loss order on an open position can reduce the margin necessary to maintain that position.
Product: Wall Street June (trading at 13,500)
Normal Margin Requirement: 2%
Minimum Margin Requirement: 0.60%
Assume the Normal Margin Requirement for Wall Street June is 2% and you decide to buy £5 at 13,500.
The Normal Margin Requirement is: (13500 x 2%) x 5 = £1350. This means your Normal Margin Requirement (NMR) for a £5 a point bet on Wall Street June is £1350.
However, by placing a stop it is possible to reduce your NMR. Minimum Margin Requirement (MMR) or a requirement between MMR and NMR can be maintained if a stop loss is placed within a certain distance from the current market.
The Minimum Margin Requirement level for Wall Street is 0.60%. Therefore, if you were to place a stop up to 0.60% (or 81 points) below/above 13,500 you would need to deposit a minimum £405 ((13500 x 0.6%) x £5 = £405).
This means your margin requirement for a £5 a point bet on the Wall Street June would be £405 if a stop was placed within 81 points of the current price, rather than £1350.
When placing a stop between the minimum (81 points) and normal Margin rate (270 points) your requirement is calculated basis the distance your stop loss is away from the current price. For example, if you place your stop 200 points away from your current level of 13,500, the minimum margin requirement would be £1000.
Orders aware margining is available on UK 100 shares, major indices and major foreign exchange pairs.
A Margin Call
Occasionally your trading resources may become negative if the profit and loss of your open positions become negative and your cash balance is not enough to support those positions. In such instances, you may be required to place additional funds into your account to return the trading resources to a positive figure.
It should be noted that when you receive notification that your account is on a margin call, you should ensure that you either fund the account or reduce your positions sufficiently to get the account back onside as soon as possible.
On closure of any open positions you will realise a profit or loss which is subsequently reflected in your cash balance. The initial margin will no longer be required and is returned to your trading resources. Again, assuming that you made a profit of £100 when closing out the Vodafone position your account would appear as:
Trading Resources: £600.00
Let’s take another example. Suppose you take a short postion on say, XYZ Company at 400p for £15 a point. This is the equivalent exposure of £6,000 (400 x £15). If the margin on the trade were 10% this would mean that you would have to have £600 in your account to place this trade. IF the stock price falls to 350p, you will make £15 x 50 = £750. But if the shares were to rise to 435p, you will have £525 taken from your margin account. The provider will ask you to put in more monies in your account to put the account back up to £600 which is the amount of money you need to open this trade. This is referred to as a margin call. If for any reason you don’t put in more money in your account you may be forced to buy the stock at the higher price and therefore crystallising your losses.
We can immediately ascertain the benefits of margin trading. With the increase in popularity and growth of margin trading, harnessing leverage in the correct manner can help magnify profits using small amounts of money and placing your reserve capital in an interest paying account.
But we should always remember that it is the sensible usage of derivatives rather than the abuse which generates profits. At all times we should be aware of the risks associated and seek to control losses through correct position sizing and money management. Remember never trade with money you cannot afford to lose.