CFD and Margin

Helping traders understand the concept of margin and margin requirements for CFD trading.

Margin is a common term used in the financial markets. It refers to the amount of money that a broker requires a trader to commit upfront as a guarantee that the trader can fulfill his contractual obligations to that trade when the trade is closed. If the trade closes in profit, the margin is returned to the trader along with profit. If the trade is a loser, the trader will have to forfeit the margin to the broker.

Margin is an integral part of CFD trading. It is the trader’s responsibility to ensure that he can always come up with this guarantee. If a CFD trade goes contrary to a trader’s position to the extent that the initial margin put up cannot cover the obligations, the broker will give an instruction to the trader to cover this position with more money. If the trader’s account balance is too low to carry this obligation, a margin call is issued and the trade is automatically closed to protect the broker’s commitment.

Margin Requirements for CFD Trading

The initial margin represents the amount of money a trader uses from his trading account to place a trade. As regards to CFD trading, this will represent the percentage of a trader’s account that is exposed to a contract-for-difference trade position. Depending on the broker, margin requirements for CFD trading differ. Margin will also depend on the volatility and liquidity of the underlying CFD instrument being traded. As a general rule, the more liquid the CFD instrument is, the lower the margin requirements, and the less liquid a CFD instrument is, the higher the margin requirement.

During the height of the global economic meltdown when stock market indexes were in free fall, brokers adjusted margin requirements at will and we saw margin requirements for trades significantly raised. The requirements were even more stringent during the market crashes of 1987 and October 2008.

It therefore behoves the CFD trader to fully grasp how market conditions will affect his margin requirements and what this will mean for his trading account.

eToro chart showing trading of a CFD from a PC trading platform.

How can you make money from commodities?

Just like in forex and stock index trading, margin is required in CFD trading. A trader should familiarize himself with the margin requirements of his broker for different CFD instruments. Such can be sampled out by demo trading.

Different margin requirements exist for different categories of CFD instruments. For example, margin for commodities is not as high as the requirement for stock index trading, but is usually higher than for forex trading. As such, a trader needs to have a reasonable amount of money in his trading account to cover the margin requirements.

Margin should be managed using proper risk management. Traders should never risk more than 5% of their trading account to any single trade. Adherence to such rules and picking trades carefully are the keys a trader needs to be able to trade CFDs on margin without getting a margin call from his broker.

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