Margin, or deposit requirement, in financial trading, is the good faith amount that we need in our trade account to cover a deal. The margin is not a loan, but rather a means to cover a loss.
If we wanted to purchase a stock or share from a traditional broker, and the value of that purchase is £5,000, then we’d need £5,000 available in our account to complete the deal.
A financial spread bet, or derivative based account, is a leveraged account and only a ‘margin’ of the full-trade amount is needed.
Take Sterling versus the dollar for example, a trade of £5 per pip, at the current value of this market, without a leveraged account, would cost £67,500.
However, we are only required to cover the broker’s margin.
(A margin rate of: 0.5% to 1.5% is common in FOREX and 5% in stocks and shares; but each of these can vary significantly if a market becomes non-liquid or volatile)
A margin rate of say 1% would require an account to hold £675 for the £5 per pip example.
£5 x 13500 x 1% = £675 margin (This is a non-stop calculation, a with-stop calculation reduces the amount)
If the trade goes against us, however, the margin requirement increases. Therefore, a good amount more than £675 is required to comfortably cover the trade.
It is easy to see how novice traders could get into financial trouble if they lose sight of the overall risk of such trades.
Probably why margin rates are on the increase to retail traders.