Understanding Futures Margin
The beautiful challenge of trading futures is that the high financial risk goes hand in hand with speedy returns and speed is what attracts a handful few thrill-seeking traders. The high leverage ratio offered by trading futures also means that this type of investment is not for the average Joes.
Unlike dabbling with the stocks market, futures traders need to retain additional fund as a margin to control risk of loss in any given trading activities. Bear in mind that the risk of loss in futures trading goes in tandem with the opportunity to gain profit.
In layman term, the leverage of a $10:$100 ratio on a $100 wager could mean two things: either you stand to gain $900 or risk losing $1000 actual money.
There are two kinds of margins that you should be aware of in futures trading. The term “margin” refers to two levels of minimum margin – Initial and Maintenance Margins.
About Initial Margin
Initial Margin is a deposit required when a trader initiates a position, meaning buying (long) or selling (short) futures contract(s). Before the start of any futures trading activity, your broker will collect Initial Margin, which is a form of collateral or performance bond that is returned to you once you have closed out all your open positions (net of transaction fees, losses and/or any amounts owing to your broker).
Generally, the Initial Margin is determined by the futures exchanges and is between 10% and 25% of the underlying futures contract value. One point to note is that Initial Margin will change periodically depending on the market conditions.
Some futures broker firms require a higher Initial Margin than the minimum margins set by the futures exchanges to prevent frequent margin calls whenever the level of Initial Margin is reduced by trading loss. Initial Margin may be posted in the form of USD or MYR cash, selected foreign currencies, approved stocks and letters of credit/bank guarantee.
About Maintenance Margin
Maintenance Margin is the minimum top-up level needed in a trader’s trading account to continue holding the futures positions and is usually lower than the Initial Margin. If your position generates a loss that is greater than the Maintenance Margin level, you will be asked to top up your trading account within a stipulated time, failure of which may result in forced liquidation of your positions.
Your broker will also revalue your portfolio at the end of each business day based on settlement prices determined by futures exchanges, and your account will be credited (profit) or debited (loss) accordingly.
On the other hand, if your position results in a profit, you may be allowed to withdraw excess funds up to the Maintenance Margin level from your trading account.
For example, suppose the fund in your trading account amounts to $3,000. The Initial Margin of a Noname futures contract you are interested in is $3,000. Based on the $3,000 fund in your trading account, you could only enter a position (buy or sell) for one contract. Assuming the Noname futures contract price drops by $500, you are now below the Maintenance Margin and would probably hear from your broker requesting you to deposit the additional $500 to bring back the level into the Initial Margin. However, if you have deposited a higher amount of fund into your trading account, say $5,000, your broker will automatically peruse the amount available in your trading account to continue holding your position.
Margin requirements are met if the trading position in the trader’s account starts to lose money. If the fund in the account fall below the Maintenance Margin, then it is compulsory to close the open position to recur further loss or to deposit additional funds to bring up the funds to the Initial Margin level.
This request for additional funds is known as the dreaded
margin call for the simplest reason that it also signals that you have lost a sum in trading. In short, if you place just enough fund to trade a single contract, you will tend to get margin calls every time the market tumble, and in volatile futures trading, that could mean, every single day.
Our advice? Place a higher fund amount you are comfortable to lose into your trading account and avoid the margin call.
With regard to the two margins explained above, it is wise to note that not all futures exchanges utilize the Initial Margin and Maintenance Margin requirements. Bursa Malaysia Derivatives (BMD) just have outright margin for their futures products such as the popular Kuala Lumpur Composite Index Futures (FKLI) and Crude Palm Oil Futures (FCPO).
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