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Trading CFDs? a Margin Call Is Your * Worst * Enemy!

by CFD Guru Team   ·   

In CFD trading, the concept of Margin Call is very important as it helps a lot of day traders make more meaningful decisions resulting in minimizing risks and maximizing profit potential.

This blog post will explain the important terms such as required margin, initial margin, maintenance margin and margin call and how to leverage them in CFD trading.

First of all, let’s recap some advantages of trading CFDs before covering the advantages of margins.

So what is CFD trading and why should you trade CFDs?

Contract For Difference (CFD) trading is advanced and most popular trading strategies nowadays as starting as a CFD trader is much more relaxed than other types of trading and requires much lower capital to begin.

However, that doesn’t mean it’s so simple you should jump in and start trading without any prior information and planning.

Trading CFD involves observing the statistics of financial assets.

Based on the trends you see, you develop your own expectations on whether the price of that asset will go up or down.

You buy (go ‘long’) the CFD when you expect an upward movement in price and you sell (go ‘short’) an opening position when you see the downward movement.

The first and most important advantage of trading CFDs is that when you invest in CFDs, rather than in markets like commodities or stocks, you can profit not only from upward going markets, but from falling markets as well.

As long as your expectation of falling the market meets the reality, you can celebrate your profit in your account.

What is a Margin Call and how does it work on CFD trading?

The term Margin Call describes the alert sent by a broker to notify a trader that the capital in their account has fallen below the minimum amount needed to keep a position open; i.e. the total capital a trader has deposited plus or minus any profits or losses, drops below his margin requirement.

A margin call might mean that the trader has to put additional funds to balance the account or close positions to reduce the maintenance margin required.

In order to better understand the concept of Margin Call in CFD trading, let’s discuss the important terms in this process – such as required margin, initial margin and maintenance margin – first.

Required margin

In CFD trading, required margin is the amount of investment, that is actually required by the trader to open a position.

For example, if the leverage is 1:40 and you want to trade on a value of $10,000, the required margin will be $250.

The amount of required margin is calculated using the formula:

Total Value / Leverage

Required margin consists of two parts: (1) the initial margin and (2) maintenance margin.

Both of them will be explained and discussed below in details.

Initial margin

The initial margin is the first part of required margin, on which the price changes take effect and on which profits and losses are produced.

While trading, when a position is opened, the price changes on the market affect the invested capital, i.e. initial margin.

Maintenance margin

The maintenance margin, as the name implies, is required to maintain an open position.

In order to keep a new position open, you have to make sure that the equity (the net capital) is higher than a certain percentage level of the maintenance margin.

There are different maintenance margin level requirements, which are specific to each financial instrument.

The maintenance margin is always monitored in real time and once this required margin exceeds a certain percentage, a warning email is sent out.

This warning email is referred as a Margin Call.

Margin call

So, as mentioned above, if the maintenance margin exceeds a certain percentage of the equity, the broker sends a warning email to the investor.

Margin call’s purpose is to request the investor restore the level of equity or to warn of liquidating a position in order to balance the situation.

Let’s see margin call example to understand how to put a margin call option into practice while trading CFDs.

Margin Call Example

Let’s imagine you completed the initial registration and deposited $500 via credit card into your trading account. At the beginning, the balance on your account would look like this:

Available Balance$500
Equity$500
Maintenance Margin$0
Profit / Loss$0
  1. Available balance is the amount that you can use as Initial Margin = Balance plus the P&L (profit and loss) of all open positions minus the Initial Margins).
  2. Equity is the current account evaluation = Balance plus the total P&L from all the currently open positions.
  3. Maintenance Margin is the requested margin to keep a position open.
  4. Profit / Loss represents the profit and loss for all open positions

Let’s imagine it’s 10:30 AM and you buy 1 Apple share (CFD) quoted at $1,000 on one of the best trading platforms named “The CFD Trading”.

The total value of these shares is $1,000.

The required margin for these shares is 20% of the total value, i.e. $200.

The required margin is the amount you have to invest in an open position.

The maintenance margin needed to maintain these shares is 10% of $1,000 that is $100, which is the 50% of the required margin.

So after the “buy” trade opening, the balance on your account will look like this:

Available Balance$300 – spread
Equity$500 – spread
Maintenance Margin$100
Profit / Loss$0

Note that when you open the position, the spread amount is deducted from the available balance.

So you need to keep this in mind: The Margin Call option will be activated if the equity falls below a certain percentage of the equity, a margin call option will be activated.

If you keep the position open while it continues to lose, the broker will liquidate the position, i.e. he will close the position for you.

Now let’s imagine it’s 11:15 AM and the shares value went down to $975 (loss of 2.5%).

This loss of 2.5% will be calculated on the total value amount, which in our example was $1,000.

The 2.5% of $1,000 is $25, which we have to subtract from the total value amount. So the balance on your account will be:

  • Available Balance: $25 – spread. How to calculate: Initial capital $500 – spread – $100 (maintenance margin) – $100 (initial margin) – 2.5% of the total value amount = $25 – spread
  • Equity: $225 – spread. How to calculate: available balance $25 + maintenance margin of $100 + initial margin of $100 – spread.
  • Maintenance margin: $200
  • Profit / Loss: – $25 – spread

The equity represents the amount of how much profit / loss and margins you have considered.

Now let’s consider the price continuing falling down. The margin call will be executed if the equity falls below the maintenance margin.

After you receive a CFD margin call, you have three options. You can:

  1. Leave the position open and see what happens. Remember that the position will be closed by your broker if it continues to fall, or a positive recover.
  2. Add more capital to your account balance.
  3. Just close the position immediately, by yourself.

To better understand the concept of Margin Call and try it yourself, we recommend you access an IG demo account, Plus500 demo account or eToro demo account.

These demo accounts will help you personally view and better understand the terms discussed in this article.

Advantage of using demo accounts

Before you dive into day trading, which is very challenging and full of risks, we advice you to open any of the below mentioned demo accounts.

These demo accounts will help you understand everything you read in a practical way and even practice trading on real market conditions with virtual funds, which is granted to you by trading platforms.

So opening demo accounts is the great opportunity to start trading as you invest the virtual funds instead of your own real money, which is the best opportunity before you dive into trading.

IG demo account

When you open a demo account on IG trading platform, you have an opportunity to access the real trading account.

Using a demo account, you can test the strategies and practice trading with the amount of $20,000 virtual funds.

Plus500 demo account

After you open a demo account at Plus500, you can trade for as long time as you wish to.

So this is the best opportunity for you to take your time and practice trading on real market conditions before you start investing your own real money.

Open Demo Account.

eToro demo account

Another great trading platform you can open a demo account is eToro.

You can practice trading with $100,000 virtual funds the company grants you on your demo trading account.

Open Demo Account.

 

67% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you can afford to take the high risk of losing your money.

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