Margin closeouts can be so soul-destroying that some traders even cease trading altogether. Many traders simply withdraw their funds and close up shop. Margin closeouts can and do happen, and you would do well to recognize this and learn from it. We will first examine the concept of margin calls before analyzing how you might possibly survive a margin closeout. When you first learn CFDs, you would do well to become acquainted with the notion of margins and leverage. It is in these aspects that you will find the biggest risks involved with CFDs.
When you buy on margin, it is like trading with borrowed credit because you don’t have all the money necessary for the transaction. You might use money from a broker or dealer to enable you to go through with a trade.
CFD trading is often done on margin because CFDs use leverage. In a CFD setup, you don’t own the underlying asset. You are merely betting, or making a wager, that between the time you enter into a position and conclude it, the tide may have swung in your favour The tide could entail several factors, such as the price of shares, forex values, commodities and more. You are taking a position on the underlying asset, not the market. It is crucial to understand this because it marks the difference between CFDs and spread betting. You could be betting that the price goes up, down or anything in between. If you have bet correctly, you’ll “win” money in multiples of what you put down, but if you lose, you also lose in multiples. This is why CFDs are often considered risky.
How are margin and leverage related? In order to leverage funds – for example, by putting down a CFD deposit – you will need funds. Often, these will be supplied by a broker in the form of a loan that it is extended. It may be best to think of it as a line of credit that allows you to go into a leveraged deal.
What is a margin closeout? The word “close” is your clue. First, a broker can call in their margin by demanding you pay it back. This may be because the market is rapidly turning due to some surprise element. The broker needs protection; they can no longer extend your credit line and will need you to pay up the value of what you took out. It’s like a bank demanding you settle a personal loan or line of credit immediately. You will always know what a margin call value is because it’s generally agreed upon in advance.
In a closeout, the exchange closes all of your open positions. It means you are probably reaching your margin call limit, and the exchange does this to prevent you from making further losses.
The best trading advice for dealing with this situation is recognize it for what it is: a failure to manage your risk properly. Yes, there are traders who have come back from margin callouts and gone on to become spectacularly successful. These are the trading lessons to be learned from those who have survived:
If your portfolio isn’t diverse enough, you are planning to fail.
As much as you may be focused on making profits, focus enough time and energy on studying risk management.
What triggers a margin call? If you don’t know this in the various contexts in which you’re trading, you are in perilously deep waters. This is Trading 101.
Don’t be afraid to use stop orders. “Safe, not sorry” is the concept that applies.
Know what the margin requirements of your broker are at all times.