Futures and Forex Powered by the Leverage of Margin

What Is Margin?

Margin can mean many things in the financial world. Equity investors are familiar with the margin being a partial payment for stocks, usually between 25 and 50%. In the forex market, a margin is a good faith deposit to ensure that the customer has sufficient funds to cover potential trading losses. This is not to say that a margin is a fee or partial payment; it is a performance guarantee that incentivizes market participants to follow through on their end of the contract.

A margin is a good faith deposit to ensure that the customer has sufficient funds to cover potential trading losses.

Margin Examples

Margins are like the deposit when you rent a car. The deposit ensures your creditworthiness, and the rental agency is covered for any damages. The deposit is not applied to the rental charge and is refunded once you return the car and pay the rental fee. Margins work in the same way.

Margin as Leverage

Margins for futures and forex represent a small percentage of the underlying asset’s value. That means that for a small deposit, you can control the upside (or downside) of a much larger asset. Trading with margin does carry risks. Just as it can amplify gains, it can also amplify losses. Consulting an industry professional is always a good practice when using financial derivatives.

Futures Margin

Futures margins are set by the exchange where the product trades. All brokers must ensure their customers have sufficient funds to meet margin requirements. The margin varies from product to product, usually between 3 and 12% of the contract's notional value. For example, a euro (EUR) contract worth 125,000 euros (EUR) would require a $3,750 margin deposit to open.

Initial and Maintenance Margin  

• Initial margin: The dollar amount required to open a position
• Maintenance margin: The dollar amount that triggers a margin call

If the account balance drops below the maintenance margin level (usually about 10% of the initial margin), a margin call would be triggered. A customer must then add funds to bring the account back to the initial margin amount.

As noted above, the exchange sets the margin amounts for all futures contracts. Margin requirements can change at any time, depending on the conditions of the market. It is common for exchanges to raise margins when volatility increases or the market is subject to impactful news events (like Brexit). Margin changes are retroactive, so customers should be prepared to add funds immediately if the requirements change.

Forex Margin 

Forex transactions are over-the-counter (OTC), meaning they are not exchange-traded. Individual dealers set the margin amounts, which can vary depending on the size of transactions, customer creditworthiness, and frequency of activity. Some forex dealers allow margins as low as 2%, effectively giving the customer 50 to 1 leverage.

Note: Margin applies to spot forex transactions. Forex forward contracts  are not typically subject to margin requirements.

Margin: Futures vs. Forex

• Futures margins are set by the exchange. Brokers are required to make sure their clients keep their accounts fully margined.
• Futures margins vary by product, usually between 3% and 12% of the underlying asset's value.
• Forex margins are set by the individual broker and can vary significantly from broker to broker.

Conclusion

Margin is an important part of the financial world. It ensures that everyone has enough capital to keep trading. More importantly, it allows you to leverage a small amount of money to control a larger position. To learn more about the elements of using derivatives, head over to the blog section on our website.

Takeaways

1. In the futures and forex markets, margin is a good faith deposit to ensure that the customer has sufficient funds to cover potential trading losses.
2. Margin is not a fee or partial payment. It is money allocated for the duration of the trade to ensure performance.
3. Forex transactions are over-the-counter (OTC), meaning they are not exchange-traded, so individual dealers set the margin amounts.

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