Margin Trading

Shorter-term speculators and day traders can utilise a spread betting account to get access to a leveraged exposure to any of the main global indices or equity stock prices. And those who have pessimistic views can take short positions and profit from anticipated falls in stock prices or utilise the leverage effect to hedge a longer term portfolio.

But what is Margin?

Margin is the amount of money that you have to deposit, or already hold, in your spread betting account, in order to trade. But as spread bets are ‘leveraged’ trading instruments, this margin will only be a fraction of the overall value of your open trading positions – typically between 1 per cent and 10 per cent.

Margin trading allows for magnification of small market price movements by depositing only a fraction of the total market value of a trade. Margin therefore enables you to magnify your return on investment. However, your losses will also be magnified, so margin trading is risky and not suitable for all investors.

Margin rates vary between different spread betting providers; some typically allow for leverage of up to 10x on share positions where an investment of only £10,000 can be used to control a spread betting position of up to £100,000. It is also important to understand that margin trading can also work against you, and while profits can be magnified so can losses. You should use leverage with caution.

One of the biggest advantage of spread betting is the ability to trade on margin. Margin trading allows you to leverage a small investment for a much greater market effect. This attribute is especially attractive to day traders where price movements are typically small. The amount you can leverage your deposit capital depends on the spread betting provider.

When trading spread betting, you deposit a small amount with the spread betting broker which allows you to open and close trades for many times the value of your deposit. The amount you deposit with your spread trading provider is referred to as margin collateral.

When you open a spread trade, this collateral is practically left intact until you close the trade again when the profit or loss is credited or debited to your account. i.e. the collateral acts as a guaranteed for any potential losses you might incur in your margin trading activities.

When you open a spread betting trade, a percentage of your account deposit (collateral) is used to cover the trade, and this amount won’t be available in your account to open other trades. The amount that is required as collateral changes depending on the price movements of the market you are speculating on. Thus, if you have already open trading positions, the amount that is tied up / available to open new trades is constantly changing.

The level of margin depends to a large extent on the liquidity and volatility of the associated shares or other financial instrument, but for the large stock caps it will tend to start at around 5% or 10%. This of course dramatically increases the possible returns on your capital but also magnifies the potential loss, hence why its important to plan your trades and carefully manage the risk.

Note also that because of the fact that spread bets are margin-traded instruments, you have to pay financing charges for holding trades open overnight so holding out positions for long periods of time (6 months+) can prove expensive.

Margins

There are two types of margin, which you may have to pay in connection to spreadbets. The first is initial margin and the second consists of variation margin. The initial margin consists of the amount that you have to deposit with your spread trading company to permit you to open the trade. It is in effect a security guaranteed that you are required to deposit and normally amounts to 10% or less. The variation margins is the unrealised profit or loss when you open a spread trade. This is equivalent to the pound value movement in your open trade when compared to the prevailing market price.

Margin Calls

Margin trading can work in your favour but it can also work against you if you are on the wrong side of a position. In most instances your spread betting account will not be permitted to go into negative territory. In any case you will be informed of the variation margin short-fall by making a margin call (via e-mail, fax, sms message, telephone or via post). If a stock price or other asset keeps going against your position and you margin deposit becomes inadequate to cover the consequent loss, you will be required to deposit extra funds or close or reduce your positions. Trigger levels may be set depending on the percentage of margin needed to cover the positions and the client’s net free equity. Failure to take action may results in your positions being reduced or automatically closed without further notice.

You only need a portion of your total exposure (margin) to place a bet. If you only place enough cash in your spread betting account to cover, say 50% of your exposure, then in a sudden extreme downturn in the share price, say a 60% drop in the share price, your position will be closed out by your spread betting company and you will be out of pocket. That is, unless you are quick enough to top up your account when a margin call is sent out. My stance, at least with AIM companies like this one, is to deposit enough to cover my full exposure knowing any downturn will be fully covered and I will be in no fear of a margin call.

Dangers

Spread betting providers make more money by offering lower margins but this encourages gamblers to trade on higher stakes and eventually lose.