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CFD trading for beginners: The ins and outs of the initial margin

by , 02 June 2015

Trading contracts for difference (CFDs) gives you an opportunity to profit from the movements of share prices.

Not only can you make money from shares rising in value, you can also profit when they fall in value.

To do this, you trade on margin. To open a trade, you need to put down an initial margin.

So what exactly is the initial margin? And how does it work in practise?

Read on to find out…


What are CFDs?


Before we go any further, let’s just define what CFDs are.

When you trade CFDs, you enter an arrangement with another party. This arrangement means you exchange the difference between the closing price of the contract and the opening price of a contract with a CFD market maker.

If you buy CFDs (enter a long trade), you profit if the price of the underlying share rises in price. The seller will pay you the difference between the closing and opening price of the contract.

If you sell CFDs (enter a short trade), you profit if the price of the underlying share falls in price. The buyer will pay you the difference between the closing and opening price of the contract.


How the initial margin works when you trade CFDs


When you trade CFDs, you’re trading a geared instrument. This means there’s a money multiplier effect at work.

This gearing comes from trading on margin. The initial margin is a small deposit that you put down to open a trade. This can range from 8% to 25% of your overall exposure.

For example, let’s say you decide to buy 100 Company ABC CFDs.

Shares in Company ABC are trading at R100. If you buy 100 CFDs, you’re overall exposure is R10,000, yet to open a trade you only need to put down an initial margin of 10%. In other words, R1,000.

To keep your trade open, you need to maintain this initial margin. In the event your trade loses money, your broker will deduct more money from your trading account to keep your margin at the same amount.

It’s this initial margin that allows you to magnify your profits (and losses) when you trade CFDs.

So there you have it. The ins and outs of the initial margin when you trade CFDs.

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CFD trading for beginners: The ins and outs of the initial margin
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