Apologies – I expect you’re sick and tired of hearing me bang on about margin requirements … but it’s important to know if you’re at risk of having your positions closed down come 1st August.
New margin close out rules (in addition to the other new legislation we’ve already looked at) could be about to plunder your account …
What is margin close out?
So far, we’ve looked at initial margin requirements – this is the ‘deposit’ that your broker wants to see in your account before they’ll let you enter a position.
But what happens as that trade plays out?
If your trade moves straight into profit – that’s fine. Your margin requirements will stay the same.
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.
Let’s say that you’ve just £150 in your trading account.
You’ve opened a trade that’s required £100 in margin. That open position is now showing a £51 loss.
Brokers are now required to close out positions as soon as they’ve eaten into 50% of their margin. I.e. in the example above, if your trade was showing a £100 loss, you’d only have a £50 credit on your account, which is just 50% of your total margin requirement – at that point, your trade would be automatically closed out.
The broker I’ve spoken to has advised me that they’ll email out a margin call to clients when they hit 75% margin. But, 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.
With these new regulations, this could become a too-common experience for traders, so PLEASE watch out.
My advice would be to always add up your initial margin requirement and your risk on a trade to give you a full margin requirement for that position – that way, even if you run to a full drawdown on that position, you should be safe from 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. (I’d recommend a little more than that for comfort’s sake.)
I’ll be honest here – I just don’t know how slippage will affect this. If brokers are required to close out at 50% margin, I don’t know if they’ll be required to stomach the cost of any slippage (wouldn’t that be a nice turnaround?)
I think there’ll be an element of discovery as we tread this new path over the next few months, but I really want all home traders to be as well-prepared as possible going into this. I’ll be putting together all this information, and more, into a short guide very soon so you can have it all at your fingertips.
If you’d like help calculating new margin requirements, please check out my margin calculator here.