Learn More About Contract For Difference Margin Calculations

Contract for difference Margin requirements
An initial margin amount is required to open a CFD position, either long or short. There are a couple of sorts of margins that are applied to the entire value of a CFD position. They are initial margin and variation margin.

Initial Margin
Initial Margin is the initial deposit needed to open a position. For Australian equity Contracts for difference, this ranges from between 5% to 50% of the whole notional value of the position. Hence, if you purchased 10,000 XYZ CFDs at $1.35, you would be required to have not less than $1,350 within your account to cover the minimum margin prerequisite (10% of the total position size of $13,500). The margin prerequisite for index and foreign exchange CFDs can even be as low as 1%.

Variation Margin
Variation Margin is the difference between the initial margin and the margin required to keep the position open as the position value changes. E.g. if bought 2,000 XYZ CFDs, at $5.60 it would give you a position value of 2,000 x $5.60 = $11,200. Assuming XYZ is margined at 10% you would want a minimum $1,120 initial margin to open this position. If XYZ goes down to say, $5.40, you will now have a loss of $400 ($0.20 x 2,000). This loss (called variation margin) is subtracted from the initial margin of $1,120, leaving a deposit of $720. Since you continue to hold 2,000 XYZ contracts at $5.40 you have got a margin requirement of $1,080 (i.e. 2000 x 5.40 x 10%). However , there is now a paper loss of $400 and the initial margin has been reduced to $720. This is $360 less than the margin required to keep the position open, which means more margin is needed to top up the account. The deficit in margin is known as a shortage in equity. If you can’t sustain your margin requirement you will be unable to extend your position however you will always have the ability to reduce or close a position.

Equity Balances
The equity (or balance) of your account will rise and fall in accordance with the cash you’ve deposited or withdrawn from your account, the profits or losses affecting your account and the size of the positions held. During the trading day your account balance, as well as all open positions, are valued against the prevailing market rate. Hence your equity balance is continually calculated in-line or marked-to-market with market movements. Your end of day account balance is calculated using the mid-closing rates (or the final traded price). The equity balance is used to assess your available margin against existing positions, and possible new positions you may wish to take. Your cash balance is used to determine if there is a requirement for extra margin deposits in your account. Once a CFD trade is opened, variation margin requirement must always be maintained on your open positions. It’s your responsibility to ensure that your account is adequately margined at all times, particularly during volatile trading periods. You’ll only be allowed to buy and sell and retain open positions on the basis of cleared funds in your account, not on promised funds or funds in transit therefore you have to allow enough time for money to clear when depositing cash into your account.

If a position turns into profit, the increase in the equity of your account makes it possible for for more positions to be opened.

Shortage in Equity
A shortage in equity occurs when the account balance falls below the specified initial margin. Accounts with a shortage in equity are generally only allowed to reduce open positions, until the equity balance is in more than the required deposit. No new positions can be opened until this situation is rectified.

Margin Calls
If ever the market moves against you and your equity balance falls below your initial margin you usually have the option to:
i. close one or more of your open position(s), to reduce your initial margin to the required level; and/or
ii. add more money to your account to maintain the initial margin.
This is the initial trigger level for margin, known as the ‘Margin Call’, which you must add additional funds to keep your open positions.

Stop Out Level
You will be at risk that your open positions will generally be closed when you have less than 40% of your required initial margin (i.e. 40% of your position size) however this may vary between CFD providers.

Margin, leverage and risk
Margin and the associated leverage can be very useful if you use it correctly. It can also be devastating to the inexperienced trader who has little understanding of the dangers of using leverage with no defined risk management plan. There are several ways of using the leverage available by trading Contracts for difference, from the most conservative to the most aggressive. The way in which you use leverage will depend on your personal circumstances.

Prior to trading CFDs make sure you read the Product Disclosure Statement (PDS) your CFD broker issues as this will explain in detail how your CFD broker deals with margin. You must also read this free guide to CFD trading, which explains leverage and margin in detail.