Margin trading

Margin trading is a way for traders to use leverage for their exposure to the financial markets, such as indices, forex, commodities and stocks. This article explains what margin is, the benefits and risks, how to place trades, including what an initial margin requirement is, and includes examples in the financial world.

KEY POINTS

A trader only needs to deposit part of the full value of the trade
Because profit and loss are based on a trade’s full position, margin trading can amplify both
The margin amount or percent is how much of the transaction value you need to have in your account to make the trade.
Requirements depend on each individual asset; for example, 20% for shares, 5% for forex and 5% for indices
It's typically used through derivatives like spread bets and CFDs

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What is margin?
Is it the same as leverage?
How does it work with spread bets and CFDs?
Buying on margin: an example
Selling on margin: an example
How does it differ from short selling?
How to calculate margin
What are the benefits?
What are the risks?
How to trade with margin
Margin account vs cash account
Practise on our trading platform

What is margin?

When using margin, this allows you to trade larger amounts by depositing a smaller initial outlay. You only need to deposit a percentage of the full value of the trade to open a position. This deposit, or initial outlay, is known as the margin requirement. You can invest more than the money that you already have in your trading account by borrowing money from your broker to leverage your trades and get higher returns.

It is important to remember that with margin trading, profits and losses are based on the full value of your trade. Margin trading can magnify gains, but it can also significantly magnify losses if the trade moves against your predictions. As a result, it is possible that you could lose more than you deposit. Margin trading can be a double-edged sword, so it makes sense to research the markets, build an effective strategy, and create your strategy template before you start trading.

Spread betting and CFD trading are popular forms of financial derivative trading that enable traders to trade on margin. Spread betting is available in the UK only, while CFD trading is available globally across many countries. Learn the difference between spread bets and CFDs here.

Is it the same as leverage?

Trading with leverage or margin are similar concepts, expressed in different ways. Margin trading is how much of the trade value you need in your account to initiate the trade, such as the 20% discussed above. Leverage is the size of the position relative to the amount of capital required to initiate the position. For example, a £10,000 trade with £2,000 in the account means a leverage ratio of 5:1 is being used.

Different financial instruments have different margin requirements. For example, at CMC Markets, we offer 20% margin when trading on shares, 5% or less on many forex pairs and 5% margin on most indices.

How does it work with spread bets and CFDs?

A trader making a spread bet or CFD trade doesn’t own the asset being purchased. Rather, they are opening a contract that will make or lose money based on how the underlying asset performs.

The margin rate lets the trader know how much capital they need in their account to place a spread bet or CFD trade. If they are trading on a forex pair with 3.34% margin, then they only need to have 3.34% of the trade value in the account to initiate the trade. The trade value is provided on each order ticket within our platform, along with the margin requirement in GBP (or whatever currency the account is denominated in).

In a CFD trading account, the trader decides how many contracts or units of the asset they wish to purchase. This determines the trade value. For example, they may choose to buy or sell €5,000 on the EUR/USD when forex trading or buy 100 shares of stock.
In a spread betting account, the trader chooses how much they wish to risk for each point of movement. This determines the value of the trade. For example, they may choose to risk £1/point in on an index, currency pair or stock.

Buying on margin: an example

Assume a trader with a margin account wants to buy 10 shares of Vodafone stock, trading at £115. The value of this transaction is £1,150, but the margin trader is only required to have 20% of this in the account, or £230.

Assume the shares rise to a price of £130, and the trader sells. The profit is £1,300 - £1,150 = £150. That is a £150 profit on £230 because that is all that was required to make the trade, setting a profit of 65%.

Had the trader accessed a cash account with £230 in it, they would have been able to gain exposure to only two shares, not 10, so their profit would have been £30 (2 shares x £15 profit), or 13%.

Because it was a winning trade, the trader buying on margin has a bigger, or magnified, return.

Selling on margin: an example

Selling on margin means that the broker allows the trader to deposit a fraction of the full value of the trade. Similar to buying on margin, the trader might be able to make huge profits having only deposited a percentage, and in the case of a loss, the latter would be based on the full value of the position and could extinguish the whole capital.

How does it differ from short selling?

Short selling is a trading strategy where traders can sell shares that they don’t possess with the hope of profiting from falling share prices. They can do this with a margin trading account, as this may magnify the profits if the trade is successful. However, this can also magnify the losses.

A margin account can be used to make sure a trader is diversifying their portfolio. With margin trading, you can take a short position on assets and therefore use it as a way to hedge an existing portfolio.

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How to calculate margin

Different brokerages have different margin rates for certain instruments. As a general rule, the higher the volatility for a particular instrument, the higher the margin requirement is likely to be.

The trader must ensure that there are sufficient funds in their account to meet the margin requirements. It is important to learn how to calculate the margin requirements. The margin requirement is the percentage of funds an investor must have in their account at all times for the relevant trade, in order for that trade to remain open.

It is also worth calculating ROI (return on investment) when trading on margin. Return on investment is a type of performance measure. It is used to try and work out the efficiency of an investment. ROI measures the amount of return on an investment, relative to the investment’s cost.

ROI = return of an investment / cost of the investment

What are the benefits?

Ability to leverage your exposure to the markets. It is a more efficient use of your capital because you can trade without having to deposit the full value of the position you wish to open. As all of your money is not tied up in one transaction, you can use it for other investments. Remember, that while you can make large gains, you can also make large losses from a small initial outlay.
Consequently, it is important to consider your marginal trading outcomes. Margin trading is a good way of diversifying your portfolio. For example, you may be too heavily invested in a few shares or sectors that are quite closely related, or have a positive correlation. These shares or sectors are likely to have a tendency to experience similar rises or falls in price.
Your margin account could be used to add positions in other shares or asset classes that are negatively correlated. This means that when some shares in a portfolio are losing money, other non-correlated shares are likely to be gaining or will not move at all. This can potentially reduce losses and would improve your portfolio diversification.
It is also possible to hedge your existing portfolio. For example, let’s say you hold a long position in the underlying market for a particular stock or commodity. In the event these prices start to fall in the short term, you could consider hedging the downside risk without closing out your trade. To do this, you could use your margin account for shorting the market and safeguard your underlying position against short-term falls.

What are the risks?

While gains are magnified, so are losses. Margin means you are gaining exposure to assets worth more than the cash in the account. If those assets fall in value, they can rapidly deplete the amount of cash in the account.
Spread betting and CFDs can incur overnight holding costs, which vary by asset class and be can positive (you get paid interest to hold an asset overnight) or negative (you are charged), depending on the asset and the direction of the trade.
For example, the fee on shares is the interbank rate plus 0.0082%. Interbank rates vary by country, so overnight holding costs may vary based on the asset’s home currency. This would be applicable if trading assets in more than one country. UK shares use the UK interbank rate, while US shares use the US interbank rate, and the same concept applies to other assets.
Dividends on shares are adjusted whenever a company goes ex-dividend. This means that if you hold a CFD or spread betting position in a company where you don't own the underlying share, and that company announces dividends, your account would be credited or debited on the day the stock goes ex-dividend. In effect, this means that you would not lose or gain anything from the dividend adjustment in the underlying instrument.
You could also be subject to a "margin call" if the value of your position drops below the margin requirement. The broker would then require the trader to deposit more funds, or the position could automatically be closed. Even if one particular trade is profitable, if the net effect of all of your open positions requires you to deposit additional margin, but you fail to do so, your profitable trade could be automatically closed. The client will also be liable for any deficit on their account.

How to trade with margin

Open a demo account to practise your leveraged trading strategies using £10,000 of virtual funds. Here are some numbered steps to begin the process.

Explore our product library. Once you've created an account, select an asset to trade.
Decide whether you want to buy or sell. Bring up an order ticket window and choose how much you wish to risk per point of movement (or position size).
Analyse your position size. The platform will fill the transaction value, and you will also see the amount of capital (margin) required to make the trade.
Adjust accordingly. If you have less than the margin amount, you need to decrease the risk per point or position size. If you have more capital in the account than the margin amount, this is fine.
Place stop-loss or take profit orders. This is part of your risk-management strategy, after which you can monitor the profit or loss of the trade in the ‘position’ window.

Margin account vs cash account

Margin	Cash
Only need part of the transaction value in the account at the time of the trade.	Need the full amount of the transaction value in the account at the time of the trade.
Potential to magnify profits and losses. These equal the price movements of the underlying asset multiplied by leverage.	Profits and losses are not magnified. They are based entirely on the price movements of the asset.
Margin rates vary between assets.	Rates don’t matter because the trader is funding the whole transaction.
The amount of money that is leveraged is subject to borrowing costs or overnight holding costs (discussed below).	No borrowing costs.
Traders can go long or short.	A margin account is required to enter short trades.

Practise on our trading platform

We require our clients to trade on margin, or with leverage, on all positions that they open. This increases your exposure to the financial markets, with the chance to maximise profits. However, remember that losses can be magnified to an equal extent if the trade is not successful. Therefore, we suggest that you put in place an efficient risk management strategy before trading the live markets.

Our online trading platform, Next Generation, offers traders the chance to practise first with £10,000 of virtual funds on a risk-free demo account. This means that you can familiarise yourself with our platform and execution and order types.

FAQs

Is buying on margin a good idea?

Margin trading magnifies both losses and profits. Therefore, it could be a good idea for traders who have a profitable strategy and strict risk-management. Buying on margin may not be a good idea for traders who have a losing strategy or poor risk-management since the losses will mount much quicker than without margin. Read our guide on margin trading.

How long can I hold a margin position?

There is no time limit on holding a margin position, although there are various trading costs that may be charged for the entire amount of the position. Therefore, margin trading is typically used for short-term positions.

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