If you invest in CFDs, the chances are that you will sooner or later come into contact with the term 'margin call'. Many investors have already heard this term, but do not know what it means. Do you also belong to this group? If so, read on because on this page you can learn more about CFD investing, the margin and the margin call.
CFD investing: a short introduction
A Contract For Difference (CFD) is a financial product that allows you to benefit from a price increase or a price decrease. In fact, a CFD is a contract between a buyer and a seller. The difference in value that determines your profit or loss will be settled from the moment of the agreement. CFDs have leverage. This means that you can earn a lot of money with a relatively small amount of money.
Please note: if you buy a CFD, you are not the owner of the underlying stock. You are simply speculating on an increase or decrease of the stock price.
What is a margin?
As mentioned earlier, when you buy a CFD you do not become the owner of the underlying stock. At your request, the stock is purchased by the broker; you only pay a small part of the costs yourself. The part that you have to pay as an investor is also called the 'margin'. Suppose you want to buy 100 shares. These shares cost 20 pounds each. Normally you would have to pay 2000 pounds for these shares. If you invest in CFDs, you only pay the pre-indicated 'margin'. This is for example an amount of 200 pounds, instead of 2000 pounds. However, with this amount you get the exposure of 2000 pounds, as you wanted.
What is a margin call?
You will receive a ‘margin call’ if your account no longer has sufficient funds to keep existing positions open. The broker simply asks you to deposit extra funds on your account. This may sound a bit vague, but the phenomenon is easy to explain with an example. For convenience we continue with the example from the previous paragraph.
Suppose you have deposited 250 pounds in your account and opened the above position of 200 pounds. When the shares decrease ten percent in price, the value of your investment drops to 1800 pounds 2000 pounds - 200 pounds). To keep your position, you need to have a 200 pound margin.ever,
However, as a CFD investor, the loss of your position is entirely at your expense. This means that if you make a loss of 200 pounds this amount will automatically be deducted from your equite. However, when you do not have enough money in your account you will receive a margin call. This means that the broker asks you to deposit extra funds on your investment account.
If you do not deposit new funds, the position is usually closed automatically. Thus with modern brokers you do not end up with a residual debt. Still, it is annoying to lose all the money on your account in one fell swoop. To prevent this, it is wise to use a stop loss.
Balance is the amount, equity is the amount minus the margin and the free margin is what you do.
Setting a guaranteed stop
Tip: you can protect your positions with a guaranteed stop. This means that you take your loss if your position falls below a certain value. By setting a guaranteed stop, you can limit your loss in a certain position.