So as we have seen in the earlier lesson when you have open trades, your available margin will go up or down constantly depending on whether the market is moving in the direction of your trades or not. This means that as your trades increase in profit more margin becomes available. Conversely, if your open trades go against you into loss and you let those losses increase, you can run out of margin.
If this happens, the spread trading company will contact you pretty quickly for a 'Margin Call'. In other words, 'Please put more money in your account right now!' You are not given too much time for this, they are expecting a cheque in the post TODAY! If you do not do this, they can close your trades to bring your account into order. This is not a situation I recommend you get into.
Any gains you make when you close a position will be added to your account to increase your available margin. Any losses will be deducted and decrease your available margin.
You can increase the amount of margin in your account at any time by sending a cheque to the trading company (or using the on line facility if available). Alternatively, you can request a cheque to be sent to you at any time to take money out of your account. You can also set up a more permanent arrangement such as asking them to leave a certain amount in your account and send you a cheque for any balance over that each month. If you wish to close your account at any time, they will return your margin to you plus any gains you have made or less any losses.
Finally I refer back to a point made earlier. You need margin to be able to trade but that does not necessarily mean that your entire margin is at risk if you trade with discipline. For example, let's say that you are trading the FTSE 100 Index at £5 per point. To do this might require £1000 of margin but if you decide that you will close the position if the Index goes 20 points against you - and you stick to that, the maximum you will lose will be the 20 points plus the spread of say, 6 points. A total of 26 points at £5 = £130.00.
Therefore, you can place say, £10,000 as margin in your account but decide that if your £10,000 drops to £7,000 you will close your account. This gives you more trading flexibility and helps prevent margin calls.
The dreaded margin call comes when your position has gone against you and you have insufficient funds in your account to fund the margin requirement.
Let's look at Example 1 above:
You are long DOW Futures at £10 per Point. You opened the position when the offer price of the index was at 9500 on quarterly contract expecting the index to rise. The margin requirement is £300 x £10 = £3,000 and you have deposited £3,500 in your spread betting account.
The current index bid/offer prices are 9400/9410, i.e. it is 9400 to sell your position. You have a 'paper loss' of 100 Points at £10 per Point = £1,000. The balance in your account has now depreciated by the same amount and is now standing at £2,900, i.e. you have insufficient margin to cover your position. Your spread betting company will initiate a margin call either by telephone or e-mail asking you to rectify this situation.
There are two actions you may take. Either deposit more funds into your account to cover the margin or close all or part of the position until your margin is sufficient to cover the position, e.g. if you sold at £2 per point you would only require a margin of £8 x £300 = £2,400.
In the event that you do not take any action, then your spread betting company will almost certainly liquidate your position, i.e. close all or part of your position without any further reference to you, and, if your account becomes negative, you would be liable for the balance.
Always give consideration to your bet size relative to the size of your account balance. There is nothing more frustrating than having to take a loss because of lack of margin, and then seeing a few days later that your position would have been profitable.
A word of warning regarding margin trading or trading on margin as its sometimes referred to. Highly leveraged positions can be extremely profitable but can also lead to big losses. Consider this: if you bought £10,000 worth of shares in the traditional manner through a broker and they depreciated by 20% you would have to pay the £10,000 up front and would realize a £2,000 or 20% loss.
Dealing costs, spreads and stamp duty are ignored for the purpose of this illustration. To place an up-bet on the same shares may only require a margin of £2,000 (20%), but if the share price fell by 20% you would lose the same £2,000, which is 100% of your investment!
Margin trading at its most perilous is best exemplified by the tale of derivatives trader Nick Leeson and his dealings at Barings Bank in the early 1990s. Trading on the movement of the Japanese Nikkei index, his losses mounted to £1.3 billion, enough to bankrupt Barings.
While this made-for-movie catastrophe should serve as a dire warning to those who engage in margin trading, it would be unfair to overlook the success stories. Margin trading is not new. Fund managers and banks use it to bulk up or protect their share portfolios. Spread betting, as a form of margin trading, suits those who want to risk a small amount of capital compared to the hundreds of thousands of pounds that fund managers spend.
For example, with spread bets starting from 2p or £1 a point, worst-case scenario losses can be as little as £100. At the same time, those who are more experienced can raise the ante to as much as £45,000 per point.
A simple way of describing the risk is this: If you had a pound in your hand and you bet it on a horse and that horse finishes last, you would have lost £1.
With margin trading, if you bet £1 bet on the FTSE, you could lose £4,000 (i.e. the FTSE index falling from 4,000 points to 0. That will have to be a really bad day!)
The key is for the spread better to calculate the potential losses before they place a bet...Are you comfortable with that level of risk? Can you afford to lose that much?
Be patient. Too many traders new to spread betting try and make it their goal to make us much as possible, in the quickest time period. But this usually leads to disaster because they simply take on too much risk to try and achieve this goal.
Nathan from had this to say about avoiding the dreaded margin calls -:
"Whilst the monetary value of a margin call is highly important, the initial primary evaluation is the percentage funded level. This is the equity (account valuation) on an account (account balance + credit allocation + open profit and loss), as a ratio to deposit required. This should be clearly trackable from your trading.
It is important that clients remain aware of how their positions are performing and regular monitoring of the platform enables this to be achieved. Margin call emails/SMS should be sent by the provider, ahead of the funded level at which compulsory closure can be effected. Regular monitoring of emails will therefore keep a client informed of any margin call situations which require their attention.
Clients can further reduce the likelihood of the compulsory closure of positions by operating stop losses (using guaranteed where possible), registering debit and or credit cards, so that funds can be added to an account at immediate notice and by reducing particular positions ahead of compulsory closure, as the latter may result in ALL positions being closed.
It is also important for a client to know when the markets in which they hold positions, are traded, especially when bank holiday periods are in effect. Just because it is a bank holiday in the UK, this does not stop many markets from continuing to trade.
The release of important economic data can create increased market volatility and knowing when these announcements are due is important and either funding ahead of these numbers or being in a position to react immediately in terms of depositing funds may also enable positions to be protected from compulsory closure.
By incorporating all of the above a client can help protect their account as much as possible."
Using high level of gearing/leverage is one of the fastest ways to blow your account. The moment I switched to a much lower leverage strategy it has changed my mind-seet on the concept of leverage.
Add to that the possibility of a share dropping by some 10% is infinitely far more likely than the security dropping 100%, so for someone who had bought Sainsburys' stock with leverage at 300p with a 10% stop loss order; if they had bought £12k worth of Sainsburys' stock [equivalent to 4000 shares] with a £1,200 margin deposit (i.e. using maximum leverage with 10% margin deposit) and the next few days Sainsbury were to fall by just 30p they would had had their entire account wiped out, whereas if they didn't gear they would have been £1,200 down while still holding the shares. Of course there are plenty of ifs and buts but I would say that's how most people tend to get hammered.
Which is why it is critical not to use the full margin. Obviously the 10% stop loss level mentioned above is just an example and if the share were to move up by 10% you would likewise have doubled your initial investment but it does help to highlight the dangers of being over-leveraged/under-capitalized. In a real situation you have to plan a trade and stop loss level around a support level and if it were to breach that support level, you have to write off the loss as the cost of business.
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