Candlestick Trading Blog
Futures trading, short options trading, short selling stock, and borrowing cash from a broker to buy stock or buy options all have margin requirements. The margin is cash or securities deposited in a margin account. Margin requirements are calculated as the sum of all debts or potential debts to the stock broker, called a counterparty, which must be satisfied to continue trading or to remain in a short position on a stock or option. If the current value of the trade, short sell, or stock purchase upon which the margin requirements are based drops, the trader may be subject to a margin call. This means that he or she must add cash or securities to the margin account or close out the position. If the trader does not do this in a timely manner the broker is empowered to sell the underlying stock, stock option, or future to meet the margin call.
Margin requirements are meant to protect the stock broker or clearing house that stands as counter party to trading. In margin trading or stock investing without the services of a third party the buyer or seller always has what is called counterparty risk. This means that when a contract comes due the buyer may refuse to or be unable to pay and the seller may refuse to or be unable to delivery the option, commodity, or stock in question. Trading on a stock, options, or commodities exchange that acts as a clearing house and posting cash or securities as collateral in a margin account guarantees that a contact will be settled and there will money to buy or sell the equity as promised.
Margin requirements also protect the day trader and the investor. It is always important to protect investment capital. Investment capital is essential for both the short term trading and long term investing as it is the basic tool by which traders and investors make their money. A wise trader will not risk all of his or her investment capital at once. That means that the trader will never post all of his or her assets for margin requirements in more than one trading account simultaneously in action.There are a number of sub requirements that make up the total for margin requirements in trading futures contracts, options contracts, and borrowing to buy stock shares. These are current liquidating margin, maintenance margin, premium margin, and additional margin. The liquidating margin is the minimum amount of money needed to close a position and satisfy debts. It is the money needed to buy back stock or pay the loan used to buy stocks. The maintenance margin is the amount by which the trader’s obligation to the margin accounts changes day by day with the price of the underlying security. The premium margin is the cost of paying the current premium on an options contract to exit the position. Additional margin is the money or stock needed to increase the size of a margin account in the event of a margin call. All of these individual margin requirements added together are the trader’s obligation in margin buying and selling. A major part of managing investment risk is having a strategy that limits risk through margin trading. Although trading with a margin account allows traders to greatly amplify their gain with a successful trade margin trading can also amplify losses. Trading strategies that balance risk are often wise when trading on margin.
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