What is margin close out?

 

Like many uncomfortable things in life, we prefer not to talk about them, and to act like they aren’t there.

Climate change … paying for social care … ignoring bills … take your pick!

And margin is one of those things we often sweep under the carpet.

It’s important to take a few minutes to get your head around margin requirements. Otherwise you could get a nasty surprise with positions closed out on you.

What is margin?

With leveraged trading, like spread betting, margin is the ‘deposit’ your broker wants in your account before they’ll let you enter a position.

This is called ‘initial margin’.

You calculate it as a percentage of the size of the instrument you’re trading, multiplied up by your stake size.

For example, major forex pairs have a margin requirement of 3.33%. So, if you’re trading EURUSD at 1.1650, with a stake of £2, your margin will be:

11650 * 3.33% * £2 = £775.89

How margin changes

But margin has another guise: ‘variation margin’, or sometimes called ‘maintenance margin’.

Variation margin is a more shadowy figure that comes into action as that trade plays out.

If your trade moves straight into profit – that’s fine.

But if that trade moves into a loss (even if it then goes on to swing back in your favour) – that negative on your account could bring on a margin call.

The reason for this is that the available funds your broker looks at for your margin requirement will take into account open profits and losses.

If your account balance is £1,000, but your open trades are sitting on a £300 loss – your broker will see your available funds in terms of margin as just £700.

Here’s another example …

Let’s say that you’ve just £150 in your trading account.

You’ve opened a trade which required £100 in margin. That open position is now showing a £20 loss.

That £20 is your variation margin. It’s an unrealised loss, but will required to be covered by the balance in your account IN ADDITION to the initial margin requirement.

So, what is margin close out?

Margin close out hits when the balance in your account isn’t enough to cover both your initial margin PLUS your variation margin.

In the early days of the pandemic, back in March 2020, some brokers increased their margin close out to 100%. This meant that you’d be required to have in your account enough to cover your initial margin, plus any variation margin.

In effect, this means you need your initial margin, plus the maximum risk on that trade – that would be the only way to ensure you don’t get a margin closeout if the trade moves against you.

So, let’s say you had £2,000 free capital in your account, and opened a trade on Wall St, which has a margin requirement of £1,950, and a maximum risk level of £200.

If your broker is operating at 100% margin closeout, you could get closed out of that trade if it moves against you, as once you hit a loss of over £50, you no longer have enough free capital in your account to run that position.

However, as brokers switch back to 50% margin closeout, the requirement is less onerous. In this instance, the position could be closed out if the balance on your account minus the open loss falls below 50% of the £1,950 initial requirement – i.e. if that position moves £1,025 against you, you’d be closed out.

So, for 100% margin close out, you need to have in your account:

Max risk on that trade + Initial margin requirement

For a 50% margin close out, you need to have in your account:

Max risk on that trade + 50% of initial margin requirement

(Even for 50% margin close out, you’ll need to have 100% of the initial margin requirement to open the trade in the first place.)

I know that getting your head around margin requirements can be a little taxing, so I have this simple tool you can use …

 

This estimator is for guidance only. Please contact your broker for accurate margin levels. This table does not include any charges on your account, such as spread costs, rolling fees and dividend adjustments. Your broker will be required to automatically close out your trade if you have only 50% of the initial margin in your account, so please ensure you have more than this to run a trade. Markets can move quickly and you may not be able add addition funds quickly enough if you get a margin call. Please note that these margin requirements are based on data available at the time for margin requirements after 1 August 2018. Brokers can adjust their margin requirements, so be aware that this is for general guidance only. Consult your broker directly for confirmation of margin requirements on any position. Spread betting carries a high degree of risk to your capital and you may lose more than your initial stake. Always seek personal advice if you are unsure about the suitability of any investment. ©Thames Publishing Services Ltd 2018

 

What the law says about margin close out

The 50% closeout rule came into effect in 2018 when regulation on leverage trading was tightened up. Since then, brokers have been required to close out positions as soon as they’ve eaten into 50% of their margin.

Exactly how margin close out is practised will vary from broker to broker. Some will email out to clients when they hit 75% margin. However, if markets are moving fast, you could move very quickly from 75% to 50% – and get a very nasty shock when your positions are closed out.

How to stay on the right side of margin close out

Without doubt my most painful trading experience ever was when I had positions closed out by my broker because of lack of margin in my account. I was away on holiday … left open positions (I’ve learned from that now) … and blissfully unaware of the turmoil in the markets until it was too late for me to transfer funds into the account.

These days, when it comes to margin, I will always err on the side of caution. If you’ve multiple positions running on your account, as most of us do, it’s easy to lose track of requirements if you’re cutting it tight.

So, with brokers now moving back to 50% closeout, my advice would be to always aim to have 100% margin. Add up your initial margin requirement and your risk on a trade to give you a full 100% margin requirement for that position – that way, even if you run to a full drawdown on that position, you have a good safety buffer against a margin call.

Here’s an example …

Let’s say that you’re buying the FTSE at 7500 at £1 per point, with a stop distance of 100 points.

Your margin requirement on that trade is 7500 * 5% = £375

Your risk on that trade = £100

To ensure that you’ll have 100% of your margin, even if you run to your stop, you’ll need to have at least £475 in your account. (If your broker is still asking for 100% requirement, you’ll want to have more than that to give your trade a safety buffer – there could be rolling costs along the way.)

Managing margin

If you find yourself running short of margin on your trading, there are some things you can do …

• Check your risk and exposure levels – you may be trading too big for your fund size.
• Consider changing the instruments you’re trading – margin changes according to the market you’re trading. Things like shares and commodities tend to have higher requirements. Also, as margin is calculated as a percentage of the instrument size, larger instruments will naturally have larger requirements.
• Avoid high stakes – scalping strategies, with very tight stops will tend to have high stakes. This will multiply up your margin requirements. Looking for longer-term positions, with wider stop distances and lower stake sizes will help.
• Trade less – the more positions you’re running at one time, the higher the demands on your margin.

Getting it right is a balancing act. If you get your margin requirements wrong, at worst it can mean that you get positions unexpectedly closed out on you for a loss at the worst possible moment. At best, getting it wrong means that you’re not exercising your margin enough and are underusing the money in your trading account.

If you’re in any doubt about margin and how it affects your trading, I strongly recommend that you take a look at my course on margined trading HERE. Don’t worry – it’s concise and doesn’t get bogged down in detail – just the stuff that’s relevant to your trading. (Plus, it’s free to Trader’s Bulletin members.)

 

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