Gain Knowledge About Margin Call Definition and Situations in CFD Trading
CFD trading needs the trader to understand the situation of going in a margin call. Traders forget that even though CFD allows leverage to gain market exposure using small percentage of total trade value there is the risk aspect to consider.
How does trade on a margin work?
Leverage helps you amplify the returns if market moves in assumed direction, which is a happy situation. However, the leverage risk is your losses get magnified in the similar manner as your profit.
If money management rule is not applied then losses can deplete all your deposits or more than the initial investment. For example, market requirement of specific market is 4% of total physical share value to open a CFD position. Thus, there is no need to tie all your capital on shares of a single company.
In this way, trade with margin leverages is helpful. Your extra funds can be used on other CFD trades. CFD trading is also regarded as margin trade.
What are margin call situations?
According to margin call definition, when trades are conducted on margin requirement with a broker fall below specific price level then what is deposited in trade account is a condition for margin call. Actually, when you place a buy position on margin, it means you borrow or request cash from broker to increase collateral balance.
Margin call is made by broker to reduce investor’s risk of defaulting on loan they requested under buy call margin agreement. Often traders check their margin call status after the call is actually got.
To find out whether your margin payment is due, it becomes crucial to add all the open positions margin requirements. If cash amount along with overall loss and profit value of open position is less than needed margin percentage, there will be a need to fund this short-fall. It is termed as going into margin call condition.
CFD trading example
Your account holds cash capital of $2,000. You wish to buy 1000 units of ABC Company with price $39 per share. The margin requirement offer is 5%, so you need $1950 to open trade.
If ABC Company share value falls to $38.50 then the loss will be $500 on 1000 shares [1000 x $0.50]
Here cash on account along with running loss [surplus] could be [$2, 000 – $500] $1,500.
Here the surplus is low than margin needed to open trade. Margin is not a fixed payment but a floating amount. In the above example, deposit is just 5% floating, when price falls at $38.50 [i.e. $1,925].
- Surplus = $1,500
- Low deposit requirement = $1,925
Shortfall or margin call condition
To keep position open, your capital needs to be $2,500. If share prices fall on long trade then the running loss escalates by $10 for every cent. It means on 1,000 shares of ABC Company it could pile up to $100.
It is the best way to ensure that your account holds sufficient funds to cover losses for the time you wish to keep the trade open. In case, you ignore this margin call aspect then you will soon discover yourself on margin call due to lack of funds in your trade account to keep positions open. This increases the risk of having close out, automatically.
What steps to take if you find yourself on margin call?
You have 3 potential options –
- Close the trade position
- Decrease your position size to free some equity
- Add extra funds in your account for short fall coverage and sustain further losses
You can check this site out because they offer margin level indicator on their platform. It displays sufficient margin needed and warn you about the trade position automatically getting closed if margin level keeps falling.