Contracts for difference

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3. Initial margin

The initial margin is the amount that the broker will require you to deposit in your account when you open a CFD. It is not a cost of trading so much as a guarantee of your contractual commitment. Put crudely, it is money which your broker can apply towards any losses you sustain.

Usually initial margin is set at 20% of the total contract value, but brokers have discretion to set lower or higher margins according to the track record of the client and the volatility of the underlying share.

Suppose that you are interested in a company whose shares are trading at 200p.

• If you were buying the 5,000 shares outright, you would need £10,000 in your account to pay for them. You would actually exchange ownership of that cash for ownership of the shares.
• If you buy CFDs equivalent to the 5,000 shares, and the initial margin is 20%, you would need £2,000 in your account.

Whether you buy the shares or buy the CFDs, you still have exposure to the price movement on 5,000 shares. The difference is in the cash outlay: buying the shares required £10,000; buying the CFDs required £2,000. The £8,000 you've 'saved' by buying the CFDs can be used to make other trades, so with the same amount of capital you can gain exposure to a far larger parcel of securities. This is known as 'leverage'.

The significance of leverage is that if you are a successful trader, your return on capital will be greater than if you just used your money to buy shares, but, if you are not successful, so will your losses.

Initial margin No. of shares      Current share price    p Broker's Initial Margin    % Contract value:  £    Amount of Initial Margin:  £

Sums held on margin in your account are frozen in your account until the contract closes out. In other words, you can't use the same money as margin on another CFD trade, or withdraw it from your account.

1. What are CFDs? 2. The benefits of CFDs 3. Initial margin 4. Variation margin 5. Commission costs 6. Interest payments 7. Dividends 8. Example of a long and short trade 9. Comparison of CFDs to share investing 10. Comparison of CFD trading to spread betting 11. Types of order 12. Stop losses 13. Strategies: Pairs trading 14. Strategies: Hedging an equity portfolio 15. Opening an account with a broker 16. Conclusion

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