When you trade contracts for difference (CFDs), it’s very important to keep an eye on your balance. This has nothing to do with falling over, but everything to do with whether and how much you are able to trade. Unlike stocks, where you spend your money and wait for the right time to sell, CFDs work in a way that constantly changes the balance in your account. The equity (also referred to as balance) of your CFD account will vary in accordance to the money you’ve remitted or withdrawn from your account, the gains or losses accrued and the size of the trades held.
Shortage in Equity
A shortage in equity occurs when the account balance falls below the required initial deposit margin. The balance or equity that you have in your account is affected not only by how much the trades you made cost, but also by their on-going value. This is called marking to market, and is a principle commonly used with margin-traded instruments and other derivatives apart from CFDs. As the contract values change in tandem with market movements, your broker will vary the balance of your account, updating it to the latest prices.
This happens continuously through the day, and at the end of the day your equity is calculated using the final traded price. Note that the equity balance is utilised by your broker to check your available margin against existing trades, and any new CFD positions you may be looking to take. Your cash balance is used to check if there is a need for extra margin deposits on your account – once a new trade is opened, variation margin should always be maintained on your open trades.
The movements of the market are very important for two reasons. First, if the amount in your account drops below the required margin, you will receive a margin call to deposit more money. If you ignore this then the broker may sell your positions for you to cover any losses. Secondly, if you are an active trader, you may find that your account is not seriously so much in the red so as to require a margin call, but losses are such that your broker doesn’t allow you to place any new trades. In such a situation you will usually only be allowed to reduce open trades, until the equity balance is in more than the required deposit. Conversely, it should be noted that this also works in reverse – if a position turns into profit territory, the increase in the equity of your account makes it possible for more trades to be opened.
It’s also important to note that you are only allowed to trade on the basis of cleared funds within your account, so it is not sufficient to simply send a check and expect to start trading again right away. For this reason you have to allow sufficient time for the funds to clear when depositing monies into your CFD account. Money management is very important when you are share trading, but even more important if you trade CFDs and other derivatives.
While you can expect your broker to contact you any time you need to make up your balance to cover the margin requirement, it’s a good idea to keep your own account well in the black rather than relying on this. It is your responsibility to make sure you have your account properly funded, and if you miss a margin call you may find your broker liquidates some of your positions that you would rather he did not. You have no claim against him for any potential lost profits in this circumstance.
The other reason that you would wish to keep your account clearly in credit is as mentioned above. If you are active trader, there’s nothing more frustrating than spotting an opportunity, trying to place a trade, and being informed by your broker that, because of perhaps a temporary drop in values of your existing positions, your account is not sufficient for the new trade. This is especially frustrating if you find that your new trade would have immediately turned into profit if only you had been able to place it.
The final point on trading CFDs is that you are responsible for your level of risk and for making sure that your account is sufficiently margined always, especially during volatile market conditions. Consider carefully the size of trades that you place, and do not just trade to the maximum level allowed by your broker.