CFD Margin
What is it - How it works
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Last update : March 2013
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- Deposit margin - sometimes called initial margin, and
- Variation margin - sometimes called mark-to-market margin or maintenance margin
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| Variation Margin - What is it - How it works |
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CFDs as you know are different from buying shares in the stockmarket. If you buy 1,000 shares of Vodafone at £1 a share and hold the position for 3 months before selling out at £2, the profit will obviously be 1,000 x £1 = £1,000.
But when buying the physical shares rather than CFDs you won't realise a profit or loss in your account until they're sold, and that's an important point to understand. So in the above example you only earned the £1,000 profit when you sold the shares.
Margined products work differently because all profits and losses are credited and debited from an account in real-time and this is called variation margin. For example -
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- You buy 1,000 of Barclays at £1.00 using CFDs
- The market moves sharply higher and you sell them 4 weeks later at £2
- Within this 4 week time period you'll be credited the daily profits and debited the daily losses as the share price moves higher and lower in real-time
- So although the total trade makes a profit of £1,000 this is credited over the 4 weeks - look at the table below to see this in action
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| Note, that although the trade is open for a total of 4 weeks I have only indicated the first 5 days of trading to show how variation margin is dealt with from one day to the next. |
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Day 1
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Day 2
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Day 3
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Day 4
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Day 5
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| Barclays end of day closing price |
£1.05
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£1.00
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£0.95
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£1.06
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£1.12
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| Maintenance margin (daily) |
£50
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(£50)
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(£50)
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£110
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£60
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| Maintenance margin (running total) |
£50
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£0
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(£50)
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£60
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£120
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| What is interesting to note in the above table is that maintenance margin can be both a positive and negative figure. On day 1 it's a positive £50 but on day 3 it's a negative £50 before going positive again on day 4 and 5 |
| Another example - Maintenance margin over 2 days |
- Today you buy 1,000 shares of XYZ Industries at £3.00 using CFDs
- Tonight they close at £3.25 and so your account will be credited with positive maintenance margin of £250 (1,000 x £0.25)
- However, the share price reverses the following day and you sell out at £3.00, the price where you initially bought the CFD position
- £250 in negative maintenance margin will therefore be debited from your account
- So although it was a scratch trade (zero profit/loss) it looked like you made a profit of £250 one day and then a loss of £250 the next - that's maintenance margin at work
- Note - in this example I haven't considered commissions or financing charges to keep things simple
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| Why is variation margin so important |
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Because CFDs are a levered product.
Without this leverage a trade could go horribly wrong and the trader might not be able to pay the loss when the position is liquidated. But as maintenance margin accounts for any losses on a real-time basis it's hard for a trade to get completely out of hand.
One final point - If you can't pay any margin owed by the end of the day your broker has the right to take over your position and close it, usually of course for a loss. And sadly there's little a client can do in such a situation as the broker's official terms & conditions will have been broken.
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