Margin Trading
Trading on margin means borrowing funds from a broker to purchase securities. You only pay a certain percentage (or margin) of the value. This allows you to trade beyond your own available funds.
A simple example:
Suppose you have cash of €3,000 but you would like to buy stocks worth €10,000. You then could wire additional funds to your account, wait for their arrival and then proceed with the purchase.
Is there not a more clever solution? Yes! The broker could also collateralize your cash and lend you more cash! By that you can tap into additional funds to make the purchase of €10,000. The broker would only require a security deposit, also known as an initial margin, of €3,000. The outstanding amount of €7,000 is lent by the broker.
Margin trading allows you to take on greater obligations without having the corresponding cash on hand.
Now let’s assume the stock you bought worth €10,000 goes up by 1% and is now worth €10,100. The gain of €100 is all yours! What does this mean for your equity? It rises from €3,000 to €3,100. This is an increase of (€100/€3000) = 3,33% although the stock price only increased by 1%.
| Trading with only your own funds | Trading on Margin | |
|---|---|---|
| Initial Deposit | €3,000 | €3,000 |
| Available to invest | €3,000 | € 10,000 |
| Purchase | €3,000 | € 10,000 |
| Remaining available funds | € 0 | € 7,000 |
| Profit from Investment (it goes 1% up) | € 30 | € 100 |
| Return on your capital | 1% | 3% |
Margin trading can magnify your investment returns, but it also increases risks. You need to carefully monitor your positions and manage risks to ensure that you can fulfill the obligations associated with trading on margin.
How does trading on Margin work?
A margin account enables you to trade with additional funds, which allows you to enter bigger positions. Therefore, your available funds exceed your cash amount. The trading platforms clearly demonstrate your advantage.
The cash balance is negative which means you borrow funds.
We can still make use of available funds: Our securities serve as a collateral and allows for borrowing more cash.
And when you try to make a purchase about, let’s say, €10.000, you only need to post a fraction of that value as a collateral: The so called Initial Margin.
The initial margin changes only by a fraction of the purchase amount as indicated by the “Change” in the section about “Initial Margin”.
Right-click a pending order and select “Check Margin Impact” from the menu.
The order preview window shows the impact of the order on your account. The column“Change” in the “Balances” section indicates how margin requirements will change post-trade.
To view the impact on the margin, click on “Preview” in the bottom right corner.
The margin display for the current position opens up.
Overview about margin requirements
The calculation of margin in theory
Interactive Brokers uses a risk-based model called Portfolio Margin to determine margin requirements based on historical volatility. There are different calculation methods depending on the product, two of which we explain here:
Both are mathematical methods to simulate various scenarios for your portfolio and calculate the risks of options and futures:
- TIMS scans your entire portfolio to analyze risks and simulates the two largest positions at ± 30% and all others at ±5% to examine the risk of low diversification. The calculation also considers the impact of extreme price fluctuations and high concentration of risk. Therefore, changes in implied volatility of options, large positions, and remaining days until expiry have an impact, too. Please be aware that the initial margin requirement is usually higher than the minimum maintenance margin requirement.
- In contrast, the Singleton Margin Method calculates the margin requirements for small-cap stocks with market capitalization of less than $500 million. It enables the simulation of price fluctuations, with an increase of 30% and a decrease of 25%.The system selects the scenario with the highest possible loss and applies it as a requirement for your portfolio. Margin requirements for stocks typically range from 15-30% of the market value depending on the calculation.
The Chicago Mercantile Exchange (CME) developed SPAN as a risk-based method for calculating margin requirements for futures and futures options. Then, test your portfolio under hypothetical scenarios to examine price changes and the implied volatility of options. We use “in-house scenarios” to examine extreme price fluctuations and their impact on out-of-the-money options. We choose the scenario with the greatest possible loss as the margin requirement.
Frequently asked questions
If you want to trade on margin, you can upgrade your cash account to a margin account at no extra cost. However, borrowing funds accrues interest which you need to pay.
You should go to the Client Portal and select Settings. Then, choose account configuration and from there, select account type. Now, you can continue by providing your current experience with margin trading and then sign the margin risk disclosure.
Generally, it is not necessary to trade on margin. Albeit, some products require you to upgrade to that account type:
- Futures
- CFDs
- Short options and certain option strategies
You cannot buy all financial instruments on margin. Risk assets like Penny Stocks, Warrants, and issuer products often demand payment with 100% of your own funds.
In contrast to the cash account, you can, among other advantages:
- Use a higher purchasing power (balance beyond your cash)
- Sell shares short
- Trade options and combinations flexibly
- Bridge the settlement periods of stock exchange trading
Please note that trading on margin may incur interest and other fees.
Interactive Brokers does not issue margin calls, so liquidates assets when the margin threshold is reached. Accounts receive real-time Margin Warning information.
You must be at least 21 years old to trade on margin. The deposit value (net liquidation value) must be at least 2,000 EUR. If the deposit value is lower, you will automatically trade as with a cash account. You can read more about our minimum requirements.
The exchanges and the broker itself define the requirements for initial margin and maintenance margin. Generally, the margin requirements change once per day, but this can change. Additionally, some future contracts have particularly low intraday margin requirements.
