Trading on margin is not commonly done in stock trading except by professional investors and institutional traders. However, trading on margin is standard practice in the futures markets and forex trading. The ability to trade on a relatively low margin, with high leverage, is part of what attracts many speculators to futures and forex trading.
Trading on Margin
In trading stocks on margin – most common in short selling – the maximum margin allowed is usually 50%. The remaining half of the stock price is provided by a loan from a broker. In futures and forex trading the margin requirements are much lower – as low as 1% to 5% of the traded contract value – and the margin posted by a trader represents a good faith deposit. This affords the trader a high level of leverage to greatly amplify the effect of price changes in terms of the dollar amount of gain or loss in the trader's account.
If the market moves in the trader's favor, this leverage enables the trader to realize significant profits on even small price changes. However, if the market moves against the trader's position, just a moderate price shift amplified by the leverage used can lead to losses greater than the trader's margin deposit.
Initial Margin Requirements
The initial margin requirement is the amount a trader must deposit to initiate a trading position. Once a trading position is established, a trader must maintain a certain balance, typically 50-75% of the initial margin, to continue holding the position.
If the account falls below this specified maintenance margin level, then the broker sends the trader a margin call, informing the trader that they must immediately deposit sufficient funds to bring the account back up to the initial margin level. If the trader fails to do so promptly, the broker will close out the trader's market position.
For example, if the initial margin requirement for trading one gold futures contract is $1,000 and the maintenance margin requirement is $750, then if the balance in the trader's account drops to $725, the trader must deposit an additional $25 to bring the account back to the original initial margin level.