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Margins
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As is apparent from the
preceding discussion, the
arithmetic of leverage is the
arithmetic of margins. An
understanding of margins—and
of the several different kinds of
margin—is essential to an understanding
of futures trading.
If your previous investment
experience has mainly involved
common stocks, you know that
the term margin—as used in
connection with securities—
has to do with the cash down
payment and money borrowed
from a broker to purchase
stocks. But used in connection
with futures trading, margin has
an altogether different meaning
and serves an altogether different
purpose.
Rather than providing a
down payment, the margin
required to buy or sell a futures
contract is solely a deposit of
good faith money that can be
drawn on by your brokerage
firm to cover losses that you
may incur in the course of
futures trading. It is much
like money held in an escrow
account.
Minimum margin requirements
for a particular futures
contract at a particular time are
set by the exchange on which
the contract is traded. They are
typically about five percent of
the current value of the futures
contract.
Exchanges continuously monitor
market conditions and risks
and, as necessary, raise or reduce
their margin requirements.
Individual brokerage firms may
require higher margin amounts
from their customers than the
exchange-set minimums.
There are two margin-related
terms you should know: initial
margin and maintenance margin.
Initial margin (sometimes
called original margin) is the sum
of money that the customer must
deposit with the brokerage firm
for each futures contract to be
bought or sold. On any day that
profits accrue on your open positions,
the profits will be added to
the balance in your margin
account. On any day losses
accrue, the losses will be
deducted from the balance in
your margin account.
If and when the funds remaining
available in your margin
account are reduced by losses to
below a certain level—known as
the maintenance margin requirement — your broker will require
that you deposit additional funds
to bring the account back to the
level of the initial margin. You
may also be asked for additional
margin if the exchange or your
brokerage firm raises its margin
requirements. Requests for additional
margin are known as
margin calls.
source: National Futures Association
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