In investing, margin refers to borrowed money that allows you to buy more assets than you could with your funds alone. Essentially, it’s a loan from your broker that enables you to leverage your trades, potentially increasing your returns—but it also comes with higher risk.
When you open a margin account, you are required to deposit a certain amount of your own money, known as the initial margin, and the broker lends you additional funds to expand your position. It's similar to when you buy a house and take out a mortgage - you put down a deposit and the bank lends you money to purchase a property.

The requirements are quite different, however, as they use the house for security over the loan.

The Role of Margin in Trading: Concepts, Risks, and Implications

A Margin is like a security deposit that lets you rent a much bigger car (a larger position) than your cash would normally permit. If the road stays smooth (prices move favorably), you can make bigger profits; if the road gets rough (prices move against you), the deposit is at risk and you may need to add funds or return the car early.

Leverage: using a margin lets you control a much larger position (notional value) with a smaller amount of your own cash.

Collateral: it acts as a security deposit to cover potential losses and to satisfy the broker’s risk requirements.

Manage multiple trades: your available “free margin” determines how many positions you can hold simultaneously.

Define risk: your gains and losses are measured against the full position size, not just your margin, so leverage magnifies both.

Margin rules matter: there are initial margins to open a trade and maintenance margins to keep it open; if equity falls below maintenance, you may face a margin call or have positions closed to protect the account.

Analogy: CFD index trading is like driving a rental car on a highway

You don’t own the road (the index itself), and you don’t own the car (the asset). Instead, you rent a car that mirrors the highway’s speed and slope.

Your fare is the price difference between where you entered the ride and where you exit. If the highway climbs (the index rises) while you’re in the car, you profit; if it slopes downward, you lose.

The “deposit” you put down is the margin: a fraction of the notional value that the broker keeps to cover potential losses.

You can choose to go long (you benefit if the highway goes up) or short (you benefit if the highway goes down). Leverage means you can control a larger notional exposure with a smaller upfront margin, but it also magnifies losses.

Overnight financing and costs add to or subtract from your P&L if you hold the position across days.

Applying this to an index CFD (long position), Assumptions (for teaching purposes; numbers will vary by broker and product):

Example:

Index: S&P 500 (or any broad index you prefer such as the ASX200).

Current index level (entry): 4,000 points.

CFD contract: 1 contract equals $10 per index point.

Margin requirement: 5% of the contract’s notional value.

Trading direction: long (you expect the index to rise).

Step 1 – determine notional value and margin

Notional value of 1 contract = 4,000 points × £10/point = £40,000.

Margin needed = 5% of $40,000 = $2,000.

Step 2 – enter the trade

You buy 1 CFD contract at 4,000.

Step 3 – the market moves in your favour

The index rises to 4,200 (a gain of 200 points).

P&L on the trade = 200 points × $10/point = $2,000.

If you decide to close now, your result is a $2,000 profit. Relative to your $2,000 margin, that’s a 100% return on margin (for this trade).

Step 4 – the market moves against you

The index falls to 3,900 (a loss of 100 points from entry).

P&L = -100 points × $10/point = -$1,000.

You would see a $1,000 loss on the trade; depending on your broker’s risk rules, this loss would reduce your account balance and could trigger a margin call if your remaining equity falls below the required margin.

Step 5 – costs if you hold overnight

If you hold the position overnight, you’ll typically pay or earn a financing charge (the “roll”). Example: assume 2% per annum on the notional value.

Overnight cost ≈ $40,000 × 2% / 365 ≈ $2.19 per day (this is illustrative—actual rates and whether you pay or earn depend on the instrument and your broker).

Over several days, financing costs can add to losses or subtract from gains.

Key takeaways for an Indice CFD account

Leverage magnifies both gains and losses. A small move in the index can produce a large P&L relative to the margin you posted.

You don’t own the underlying index when trading CFDs; you’re exchanging the difference in price from entry to exit.

Margin acts as a security deposit. If the market moves against you, your equity can shrink quickly; you may need to add funds or close positions.

Overnight financing and spreads affect profitability, especially for longer trades.

You may be reminded of the movie ‘Margin Call’. The principal story unfolds over 24 hours at a large Wall Street investment bank during the initial stages of the 2008 financial crisis. It focuses on the actions taken by a group of employees during the subsequent financial unwind or 'Black Swan Event'.

The title comes from the finance term for when an investor must increase the securities or other assets used as collateral for a loan (margin) when their value falls below a certain threshold.  Margin trading can be a powerful tool for experienced investors looking to maximise their profits, but it requires careful risk management to avoid significant losses.

Risk Tolerance

The percentage of your margin to trade on the ASX 200 (or any other index or asset) depends on several factors, including your risk tolerance, trading strategy, experience, and overall portfolio size.

Here are some general guidelines:

Conservative traders often risk 1-2% of their capital per trade.

Aggressive traders might risk 3-5% or more, but this can increase potential losses.

Trading Style

Short-term traders or day traders might use smaller margins per trade but take multiple trades. They usually hold a trade for no longer than 24 hours.

Longer-term investors might avoid high leverage altogether and hold a trade for 1 week or more. These types of traders are called swing traders. A position trader is someone who holds a share/security for longer than 6 months. They build a position usually because of fundamental reasons.

Regulatory and Broker Limits:

Brokers often have minimum margin requirements, and regulatory bodies may impose limits to protect investors.

Example:
If you have a $10,000 trading account and follow a 2% risk rule, you might risk $200 per trade. If the ASX 200 CFD has a leverage ratio of 10:1, you could control a position worth up to $10,000 with $1,000 margin. However, always ensure your position size aligns with your risk management rules.

Important:
Always use stop-loss orders to limit potential losses, and never risk more than you can afford to lose.

Disclaimer:
This guidance is general. For personalised advice, consult with a licensed financial advisor or your broker.

Below is a link to a spreadsheet of an example of an account total, margin requirements for the contract amounts on the ASX200. These calculations allow for a maximum drawdown calculated over the recent decade of market reversals. I acknowledge my mentor Marius Zammit for his work on this document.

RISK RATIOS ASX200

Lesson Summary

In investing, margin is borrowed money from a broker that allows you to buy more assets than with your own funds, potentially increasing returns but also raising risk. It's a loan from the broker to leverage your trades.

• When opening a margin account, you deposit initial margin and the broker lends additional funds to expand your position.
• Margins can amplify gains and losses. For example, with $5,000 and a 50% margin, you can buy up to $10,000 worth of stocks.
• Losses may require depositing more money or selling assets to cover a margin call.

The movie 'Margin Call' reflects the financial crisis. It's named after the term used when an investor must increase collateral for a loan.

Margin trading can be powerful but requires careful risk management. Factors affecting the percentage of your margin to trade include risk tolerance, trading strategy, experience, and portfolio size.

• Risk Tolerance: Conservative traders risk 1-2% per trade, aggressive traders 3-5%, but this can increase potential losses.
• Leverage and Margin: Be cautious with high leverage as it magnifies gains and losses.
• Trading Style: Short-term traders might use smaller margins, while long-term investors often avoid high leverage.
• Regulatory and Broker Limits: Brokers have minimum margin requirements, and regulators may impose limits.

Always use stop-loss orders, never risk more than you can afford, and for personalized advice, consult a financial advisor or broker. Remember to align position size with your risk management rules.

Here is a link to a spreadsheet showing an example of account totals and margin requirements for trading ASX200 contracts, considering maximum drawdown over a decade of market reversals.

RISK RATIOS ASX200