Do you need futures margin explained? Margin is something many new traders don’t understand at first. In fact, even some seasoned traders don’t get it. Margin trading allows you to use leverage to purchase futures with a value greater than your available funds. Kind of like a credit card, you guarantee that you will pay off your balance.
Futures Margin Explained
- When we enter the world of futures trading, there is a concept that comes up, which can bring fear or joy into the heart of any trader, and that is “margin trading.” The reason that this term can bring so much fear is that there’s a lot of downside risk when trading on margin. And many an inexperienced trader has made a few bad margin trades and been wiped out. With this article, we wish to teach you to be an informed margin trader. So you don’t make the big mistakes that are so feared. Margin trading can provide big profits in short order, and that is their draw and benefit.
You are charged interest on your margin balance; this can be as low as about 0.75%. The exchange is always on the opposite side of our trades, which means anonymity to the market.
Because the exchange is regulated by the Commodities Futures Trading Commission (CFTC), it must have the ability to meet all obligations to pay you, eliminating any credit risk.
If you need futures margin explained even more, make sure to take our futures trading course.
Initial Futures Margin
You start with a margin account minimally funded to an “initial margin”. Which is like a down payment for a trade and is a regulated percentage of total funds that can be traded.
With futures contracts, the exchanges set this initial margin to as low as 5% or 10% of the traded contract. As an example, a wheat future is quoted at $6.362 for 5000 bussels=$31,825; with a 5% margin requirement, you can enter a long position for 5% of this, or $1591.25. With the 5% margin requirement, you have 20 times leverage, which means your gains and losses are amplified by 20 times. If the price of a bushel goes up by only 10 cents and you close your position, you have a profit of $485(6.462*5000=$32310 minus $31,825).
Which is about a 30.5% return on your $1591.25 (less your margin interest and trading fees which would be about $225, still a 16% return).
Maintenance and Margin Calls
When you are down with your margin trading, you’ll need to deal with maintenance and margin calls. Maintenance is the money required when a position is down.
And you must add funds to the account to bring it up to the initial margin. For example, our trader has a margin account with $9000 and purchases a gold future 100oz at $2000/oz with an initial margin of $8250 and a maintenance margin of $7500.
Gold has a loss of $8 per oz to $1992oz, and the balance of the total account drops $8200. As long as the value of the account stays above the $7500 maintenance margin, our trader has no issues.
But if the gold price continues to drop and goes below the $7500 mark, she will be required to add enough money to get the account back up to the $8250 initial margin. Which is referred to as a “margin call.”
Each exchange has a limited margin rate that they allow traders to use for each future. And this rate is determined with the SPAN(Standard Portfolio Analysis of Risk) program.
There are several variables that go into the SPAN program. But the recent daily volatility of the future is the most important of them.
This predetermined amount of margin required allows an exchange to know what is its “worst-case” scenario one-day move that might occur for any open futures position (either long or short).
This SPAN requirement can change at any time, and exchanges will alter these requirements depending on market conditions.
The SPAN margin limits are the highest leverage allowed. However, FCMs (Futures Commission Merchants) or brokerages can require higher margins (if the SPAN is 10 times leverage, the FCM may allow 5 times, but never 20 times) of their customers.
This can be due to the risk classification of the customer or their ability to be contacted, and is in order to lower their risk exposure.
Futures Margin Explained Summary
Because the margin is such a small part of the total value being traded, leverage gives futures traders the ability to make or lose profits very quickly.
Profits are protected by CFTC regulations. As a result, you don’t have to worry about the payment. We recommend that you do not put more than 10% of your portfolio at risk with any single trade.
The more trades you make and the greater your portfolio value, the lower this recommendation percentage is. Diversification is always needed to reduce any portfolio’s risk. Never make a trade on gut instinct; only make a trade with a reason behind it. As always, we wish you the best of luck with all of your trades.