What is a Margin in CFD?

Updated on: 6 January 2020

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The simplest definition of a margin I could give you is: using borrowed money to make investments. You will usually find a lot of definitions on the internet, but this is the essence when talking about the trading industry.

Knowing what a margin is forms the cornerstone of understanding how trading works as a whole. Depending on each broker in particular, margins will vary in terms of value and other specifics, but they all function the same – allowing you to contract loans to buy assets with the broker’s money.

The margin is basically the amount of money you choose to put in your account, acting as a collateral for the loan’s balance.

What you need to know about trading on margin

This is important, because simply knowing what a margin is won’t help you understanding what to look for when trading. And not being aware of all the essential details could get you in plenty of problems.

All in all, there are several things you need to understand:

– Your security account funds are considered collateral – Like I previously specified, all your funds filling the security account are considered collateral in case of margin loan. This means that your broker can cut his losses using those funds in case your activity goes downhill.

– Different brokers, different policies – This is probably one of the most annoying things about margins; is that it isn’t something universal. Depending on your broker, margins can require different approaches and can come with different requirements.

Furthermore, brokers usually reserve the right to modify these requirements on their own accord, which could cause you to end up in really unpleasant situations.

– The dangers of the margin call – Failing to meet the margin call will result in the broker might result to liquidating some or all the assets in your account, in order to cover that debt. The problem is that many brokers won’t even notify you of this in advance, so that you may have a chance of rectifying the problem.

As a result, you may find yourself in a pretty unfavorable situation, seeing as your account balance will quickly drop before you being able to do anything to prevent that.

– CFD trading margin can cause you to lose a lot of money – This is due to the fact that you can accumulate plenty of debt towards your broker, if you lose sight of your trading activity. What is more important is that the debt can be virtually unlimited, even if your account is clean. The balance will simply sweep to negative and will keep dropping.

– The volatility of the interest rate – Depending on each broker, interest rates vary and can suddenly, with immediate effect. And if you don’t have a backup plan to cover those cases too, you might find yourself in some pretty unpleasant situations.

Out of all these minuses, margin calls are the most dangerous ones, because they have the potential to throw your balance to negative before you even realizing what is going on. But can you avoid the margin call? Yes, you can, and there are 2 main ways to do that:

– Stick to a cash-only account – This, in return, will have 2 effects: your account will be virtually impervious to debt, you will place yourself out of the “seize the assets” zone, in case of your broker going bankrupt and using your funds to cover the firm’s debts.

– Avoid “unlimited loss” positions – Engage in trades that only come with a theoretical maximum loss. That way you can keep that extra money in separate bank accounts and have a backup plan in case you fall below the margin. As you may have already guessed it, this only works in case your broker lets you know of the fact that you are reaching that point. If he doesn’t, he will just automatically charge you.

These are 2 measures to take in order to avoid reaching the margin call. But what if you have already hit it? What then? Well, in order to avoid the situation where the broker takes measures, you can either: close the trade, reduce the value of your position or simply add more funds to your account.

How to use margin in CFD trading

Knowing and overcoming the risks regarding using the margin is important in trading. But do you know what is even more important? Knowing how to use the margin trading to your advantage. I am talking about some of the most effective strategies to help you make money with margin trading.

Now, I don’t know what your opinion on how to trade margin is, but I assure you it is more complicated than it seems. I really wanted to tell you it’s easy, but that would have been me lying. Before stepping into the ring, there are several things you need to write down. Grab a piece of paper!

Trading margins explained

1. Know your broker

What I mean by that is analyzing everything related to your future broker, including limitations, terms and conditions, guidelines, exceptions and anything that might cause you problems in the future. Like I previously said, not all brokers are alike and there are some you might want to avoid.

2. Keep yourself informed

Here is the deal. This is a piece of advice you can use in any type of trading in general, not just one relying on margins. Never take anything for granted, because even if a certain trend might seem favorable, you never know what waits for you in the near future. And one of the best strategies is to keep an eye out for any relevant news, that may influence your plan of attack.

3. Open a backup account

We have talked about this, remember? It is called a safety measure and it is just as important as the winning strategies are. Because minimizing the losses is a winning strategy. The backup account can be extremely useful in case you run into a margin call and want to keep the broker’s interference at bay.

4. Learn about using a stop loss order

Even better than treating a margin call is preventing one and stop loss orders can do just that. Instruct your broker to activate the automated Stop Loss feature, that will take over when the situation seems to steer downwards.

5. Inform yourself on the interest rates

The trading industry is fortified on the notion of interest rates. This is how brokers function. And with any margin trading, there comes a varying interest rate, depending on your broker’s profile. Don’t just dive head first into the first partnership you come across. Analyze the market and look for the most advantageous interest rates you can find. Saving money translates by making more at the end of the day.

6. If it’s not broken, don’t fix it

You have a solid strategy put in place that seems to work pretty good for you? Cool. Stick with that! Don’t try to add or take away from it, as long as it keeps delivering as intended. If your strategy is good, modifying anything about it could work both ways, despite all your careful planning.

7. Read a lot!

Yes, I have used the exclamation mark this time. This is because it is an important aspect of becoming a successful trader. This means not taking anything for granted and realizing that there is always something new you can learn. Maybe an innovative strategy or some state of the art cut-losses-boost-profits guide you can expand on. The thing is there is a lot of material out there for you to go through, which is an immense opportunity for traders just entering the trading market.

Final word

Understanding how margin trading works is just the first step in expanding your field of knowledge. The next one would be to actually apply what you have learned, make adjustments and improve on your game. I know, it is not easy, but it is definitely worth it.

If I were you, I would take my time to get acquainted with all the intricacies of the notion and only then start moving on with the basics. Trading with margin can be quite profitable for the knowledgeable, which is why I can only wish you 2 things:

Study hard and good luck!

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