A: CFD trades are margin-based transactions with the gain/loss being set by the difference between the price the CFD is opened and the price at which it is closed. Margin refers to the deposit the stock market trader must provide in order to open a position. For instance, if Barclays has a margin of 10%, the investor can pay 10% of the total market position value while borrowing the remaining 90% from the CFD provider. In other words, the trader entering a contracts for difference trade is only required to put up a fraction of the total value of the specified contract traded. Margin money is essentially a guarantee that the person (trader/investor) will honour the contract entered into with the broker. Margin is set based on risk and on what it would cost to buy the investment for its full price. By trading on margin, the trader can create significant opportunities, since he only has to tie in a nominal deposit to hold a position, meaning that only a small proportion of the total value of a position is needed to trade allowing the client to magnify market exposure. i.e. the investor is acquiring a larger exposure to a particular stock for a reduced amount of money.
Margin is thus the minimum deposit you are required to make by your CFD provider so you can open your CFD trade. Your risk level will depend upon your margin covering your margin trade. The amount required to initiate a new position (i.e. enter a trade) is referred to as 'Initial Margin'. Initial margin is usually set at a percentage of the value of the contract being traded. The Margin is set by the CFD provider. It is important to note that trading 'on margin' significantly increases risk by magnifying the extent of potential losses which can exceed the initial investment.
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Note: When you have calculated your initial margin payment, you will need to ensure that when you place a trade you have sufficient money on your trading account to cover it. Note also that if your position starts to lose money and you do not have sufficient money in your account to cover the loss, you may also have to pay ongoing margin.
A: Well, the detail of it goes on something like this -:
It has probably happened to you more than a couple of times that as a result of taking a bet from a friend or co-mate, you end up being owed an expensive bottle of champagne but never end up receiving your due...
This is cited to as credit risk in banking terms. If an investor buys a leveraged share CFD with a broker, it can only result in three possible outcomes:
- 1. Both parties owe no cash. You are happy. The broker is happy.
- 2. The broker owes you money. You are happy. The broker is unhappy.
- 3. You owe the broker money. You are unhappy. (but do you have the cash at close hand to pay the difference?) The broker is unhappy as it has now effectively lent the investor money without even knowing whether you are able to honour your liabilities and may need to resort to court proceeedings to recover payment of its debt.
This problem is solved by the broker requiring a margin payment from every investor that wishes to trade in share CFDs. The risk management from the broker's point of view is determining what the margin rate should be for the market under consideration.
There would be little basis for requiring an investor to deposit a full 100% margin for the underlying financial instrument, as the investor would then be better off buying the shares outright via normal shares dealing (and they wouldn't incur daily financing charges). But of course a 0% margin isn't possible as the broker would then have no protection. The correct answer would be somewhere in between with the margin rate being determined mainly by the liquidity and volatility of the financial instrument. Generally for blue-chip stocks (i.e. stocks quoted on main indices such as the FTSE 100, Dow..etc) margin rates can be 10% or less.
If an investor breaches his margin requirements, the broker would simply alert the client and if necessary close out a few or all of the positions to ensure the investor remains within his margin requirements. This logically requires the broker to have a good trading platform with a solid infrastructure in order to manage and control this hidden credit risk.
Margin is a cash deposit provided by investors as collateral to cover losses (if any) that may result from their trades. Remember that even if you shop around for providers offering the lowest margin rates, you need to keep in mind that irrespective of how little margin you pay, you are always responsible for the full face value of the trades you make.
A: Every trader who wants to trade CFDs is required to put up an Initial Margin (deposit) for each contract they trade. Initial Margin refers to the initial deposit required to open a position. This applies to both buyers and sellers. This Initial Margin is returned when the contract is closed out. The amount is normally set at a level designed to cover reasonably foreseeable losses on a position between the close of business on one day and the next. For UK share CFDs, this ranges from between 5% to 50% of the whole notional value of the position. Thus, if you purchased 10,000 ABC CFDs at $1.45 and assuming a 10% initial margin deposit, you would be required to have not less than $1,450 within your account to cover the minimum margin requirement (10% of your total position size of $14,500). The margin requirement for index and forex CFDs is often as little as 1%.
Example of the Mechanics of a CFD trade
An investor has been dealing in shares for a number of years and decides to start trading CFDs. He enquires with several CFD providers before deciding with which provider to open an account. The investor opens and funds his account and after doing some research on ABC PLC, he reckons that its stock price was presently undervalued. He thus decides to take a long position using a contract for difference over ABC PLC shares.
The prevailing price of one CFD contract over ABC shares being quoted by the CFD broker is $5. The investor accesses his trading account and places and order to buy 6,000 ABC PLC CFDs which order is accepted by the CFD provider at $5 per CFD. The total market value of the contract amounts to $30,000 ($5 x 6,000). The CFD broker has a 5% margin requirement on the stock so the margin equivalent to $30,000 x 5% = $1,500 deposit margin is deducted from the investor's CFD trading account. The provider charges the investor 0.10% on the face value of the open and closing trades. To open this position, the provider would thus charge the investor $30 [0.10/100 x $30,000]. In the table below you can see how the price of the stock affects the investor's return.
| If ABC's stock price... | to... | Opening and Closing Commissions | Investor would gain/lose | Return on Capital (Initial Margin, %) |
| Rises by 20% | $6.00 | $66.00 | $5,934.00 |
396% |
| Rises by 10% | $5.50 | $63.00 | $2,937.00 |
196% |
| Rises by 5% | $5.25 | $61.50 | $1,438.50 |
96% |
| Rises by 2% | $5.10 | $60.60 | $539.40 |
36% |
| Stays the same | $5.00 | $60.00 | ($60) |
-4% |
| Falls by 2% | $4.90 | $59.40 | ($659.40) |
-44% |
| Falls by 5% | $4.75 | $58.50 | ($1,558.50) |
-104% |
| Falls by 10% | $4.50 | $57.00 | ($3,057) |
-204% |
| Falls by 20% | $4.00 | $54.00 | ($6,054) |
-404% |
*This example assumes that the investor is able to close his trade at the indicated price. Gains/losses and rate of return take into account commission charged at 0.10% on the face value of the opening and closing trades, but do not take into account financing fees for holding positions overnight (which in practice will affect your returns from trading CFDs).
A: You borrow it from your broker which is why you are charged a financing fee for holding a position overnight. In actual fact, when trading a contract for difference you are effectively borrowing the whole amount of money, irrespective of the margin you put upfront - the initial margin only acts as a 'guarantee payment'. So a $15,000 CFD position is the same as borrowing $15,000
A: The standard margin is 10 per cent of the contract value. A contract for difference with a contract value of $10,000 will require a margin/deposit of $1000 (check with your CFD broker for other margins).
A: Liquidity and volatility of the underlying security dictate margin.
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