Understanding margin in CFD trading

Reviewed and Edited by: Maria Stylianou | Senior Copywriter

What is CFD margin?

In (CFD) trading, you speculate on the price movements of assets like Margin FX, commodities, indices, and shares without owning the actual assets. CFDs are traded using leverage, which allows you to open larger positions by depositing only a fraction of the trade’s total value. This initial deposit to open a leveraged position is what we call margin.

Leverage is a significant feature in CFD trading as it increases your market exposure, amplifying your potential profits but also losses. Hence, understanding the risks and rewards of CFD margin trading is essential. This guide expands on how margin works, its relationship with leverage and introduces strategies for managing associated risks to make the most of your CFD positions.

Types of margin

When trading CFDs, there are two types of margin you should understand:

• Initial margin:
  This is the minimum amount of funds required to open a new position. It acts as a security deposit, ensuring you have some capital available when entering a trade.
• Maintenance margin: It is the minimum amount of equity you must maintain in your trading account to keep an open position. It is essential to make sure you have enough money in your account to cover any potential losses.

Leverage and margin in CFD trading

Since leverage and margin go hand in hand in CFD trading, the one is directly influenced by the other. A higher leverage ratio allows traders to open and maintain larger positions with a smaller upfront amount - the initial margin.

CFD trading is tightly regulated, and margin requirements typically range from 3% to 50%, depending on the underlying asset, the broker, the trading platform, and current market volatility. Lower margin requirements increase leverage, which can amplify both potential gains and losses.

Leverage is shown as a ratio like 30:1 or 20:1, which corresponds to the margin rate expressed as a percentage. The higher the leverage, the lower the margin needed, but the greater both the potential gains and risks.

To illustrate how margin and leverage work in CFD trading, let’s use the example below:

A trader wants to buy 1,000 CFDs on a company’s shares, which are currently priced at $42.50 each. This means the total value of the position will be $42,500 (1,000 × $42.50).

If the broker requires a 5% margin, the trader must deposit only $2,125 to open the position (5% of $42,500). This margin rate corresponds to 20:1 leverage. The trader controls a $42,500 position with just $2,125 – a fraction of the stock’s total value.

Now let’s further expand on the above scenario, with the share price increasing to $45.00. Now the total value of the position is: $45,000 (1,000 × $45.00)

Since the market moved favourably for the trader and the price surged, the profit made is $2,500 ($45,000 - $42,500 = $2,500).

Because the trader opened a leveraged position and invested only $2,125 as margin, this results in a return of nearly 118% ($2,500 profit ÷ $2,125 margin ≈ 1.18).

The profit or loss is always calculated based on the full difference between the initial and final share prices, multiplied by the position size - in this example 1,000 CFDs.

If instead the share price falls to $40.00, the value of the total position decreases 1,000 × $40.00 = $40,000. So, the loss is $2,500 ($42,500 − $40,000) and relative to margin is 118%. This means the trader has lost more than their initial deposit. With high leverage, even a slight price drop can lead to substantial losses.

Effective strategies using margin

To trade margin CFDs, combining discipline with smart tactics and robust risk management is key. Let’s look at a few effective strategies traders often use.

Position sizing: Determining the appropriate position size or capital allocated to each trade is important. Since leverage amplifies gains and losses, traders tend to limit risk to 1–3% of their capital per trade to protect their account and minimise the impact of potential losses.

Diversification: Spreading your capital across multiple asset classes or markets can reduce overall exposure, as gains in one position may offset losses in another. However, with margin and leverage increasing risk, diversification must be managed carefully to avoid overextending your capital.

Technical indicators: Applying technical indicators helps you time margin trades more effectively and analyse market trends. Common types include momentum, trend, volatility, and support/resistance indicators, and can be used alone or together.

• Moving Averages: Show trend direction and possible entry/exit points.
• RSI (Relative Strength Index): Flags overbought or oversold conditions.
• Bollinger Bands: Highlight volatility and potential price reversals.
• MACD: Signals momentum shifts and trend reversals.
• Support & resistance: Indicate likely reversal or pause levels in price.

Calculating risk-to-reward ratios: Understanding if a trade is worth it by comparing potential profit to loss helps balance wins and losses over time. For instance, a 1:2 ratio means the potential gain is twice the risk—so for every $1 you risk, you aim to make $2.

How to calculate it:

1. Set your entry and target (exit) prices.
2. Choose a stop-loss level (your max loss).
3. Divide potential profit by potential loss.

Pros and cons of margin in CFD trading

Margin can be a powerful tool when used wisely, but it can also expose you to various market risks. It’s vital to strike the right balance between opportunity and risk by setting clear goals and knowing your risk tolerance.

Advantages

• Leverage: Margin enables leverage, allowing you to open and maintain larger positions with less capital and boost potential returns on small price movements. However, as said, it also magnifies losses, making it a double-edged sword.
• Flexibility: Margin trading offers access to short-term trading opportunities for various assets, with low capital requirements.
• Diversification: Margin trading frees up capital, allowing you to spread it across other positions and asset classes.
• Portfolio liquidity: Margin trading lets you enter and exit positions quickly without dedicating all your funds to one single trade, but having more capital available once other opportunities arise.

Disadvantages

• Higher risk of losses: Profits are amplified, so are losses- a leverage effect. Just as small price moves can boost returns, even slight adverse movements can lead to significant losses that sometimes exceed your initial margin.
• Margin calls: Falling below the maintenance margin triggers a margin call, which requests to add funds or close positions.
• Market volatility: Margin increases exposure to market volatility, with price swings significantly impacting your position and requiring more attentive risk management.
• Charges: Leveraged positions may incur overnight or funding charges that can accumulate over time, reducing potential profits, especially in longer-term trades.

Risk management in CFD margin trading

Since leveraged trading requires more sophisticated risk management, you need to take some steps to mitigate the possible negative side of margin.

Set stop-loss orders

Stop-loss orders automatically close a position when prices fall to a limit set by the trader. While stop-loss orders minimise losses, they don’t prevent them, especially after market closures or sharp price movements.

Respond to a margin call

A margin call occurs when account equity falls below the maintenance margin (the minimum amount needed to keep your open positions) due to unfavourable market movements. Once issued, you should immediately top up your funds or close some positions to restore the required margin level. If you fail to comply, the broker may close the position, or ‘force liquidation’ to limit further losses.

Monitor your positions

Multiple CFD positions can be open with their own margin and maintenance requirements. Regularly monitoring each one and remaining vigilant of any crucial economic events and releases is indispensable, especially in highly volatile markets.

Margin call: From theory to practice

To better understand how a margin call works, let’s use the scenario below.

A trader opens a long position on the EUR/USD pair with a $5,000 margin using 20:1 leverage. This will allow them to open a $100,000 position. The market eventually moves against them, and the EUR/USD rate drops by 1%. Then, the position incurs a $1,000 loss (1% of $100,000), and as a result, it reduces the trader’s equity to $4,000.

Assuming there is a 50% maintenance margin requirement, the trader must maintain at least $2,500 in equity (50% of the initial $5,000 margin). If losses continue and equity falls to $2,000, a margin call will be issued, prompting the trader to deposit an additional $500 to restore equity and maintain the position. If the trader fails to do so, the broker may begin closing positions to prevent further losses.

Common mistakes to avoid when using margin

Recognising and avoiding some pitfalls in CFD margin trading helps protect capital and improve performance. Some of these are:

Overleveraging: A common mistake with the use of margin is overleveraging, which happens when a trader uses too much leverage, risking more capital than they can afford to lose. As small market moves can lead to substantial losses, overleveraging increases the possibility of margin calls and positions’ closure.

Ignoring margin requirements: Traders should be aware of the specific margin requirements for each asset class. Overlooking these can lead to margin calls or even forced liquidation. Actively monitoring open positions is equally important, as acting promptly on market shifts to minimise the risk of a margin call.

Not using stop-loss in margin trading: Failing to use stop-loss orders or setting them too far from the current market price exposes traders to greater risk. Stop-losses should be used strategically. The more volatile the markets, the greater the need for carefully placed stop-loss orders.

Chasing losses after a margin call: After a margin call, traders may fall into the trap of ‘revenge trading’ to recover losses. This can lead to mistakes like overleveraging and taking emotional, rather than strategic, decisions.

What margin rates are offered by Pepperstone?

Margin requirements vary by underlying asset class. Major Margin FX pairs may require a 3.33% margin (30:1 leverage), indices around 5%, and commodities between 5% and 10%.

Margin rates and leverage levels depend on market conditions, regulation, the size of the trade, the instrument and your account currency. You can calculate this using our margin calculator in your secure client area.

How to start trading on margin

1. Choose your margin trading approach
   At Pepperstone, margin trading is done via CFDs, allowing you to speculate on the price changes of underlying assets without owning them.
2. Open a CFD trading account
   Sign up for a live Pepperstone account by following our four-step application process. Once verified and approved, you can fund your account and start trading.
   Not quite ready? Try a demo account instead.
3. Choose your market
   Access thousands of CFD instruments across Margin FX, indices, commodities, shares and more.
4. Execute your trade
   Set your trade size, apply appropriate risk management tools, and place your order. Keep an eye on the market to track performance and adjust if needed.

Conclusion

Effective use of margin in CFD trading starts with setting clear, realistic goals and determining how much risk you are willing to take on each trade. While margin unlocks the potential for greater returns through leverage, staying disciplined and not underestimating its risks gives you a true edge. Keeping up with market conditions and pivotal economic events, applying solid risk management and focusing on consistent and steady gains is often more sustainable than chasing big wins.

Margin trading FAQs

How do you calculate CFD margin?

To calculate CFD margin, multiply the total value of your trade by the margin rate.

For example, if you're trading $10,000 worth of CFDs with a 5% margin, you'll need to deposit $500 (10,000 × 0.05).

What are the initial and maintenance types of margin?

Initial margin is the amount you need to deposit to open a trade.

Maintenance margin is the minimum amount you must keep in your account to keep that trade open. If your balance falls below it, you might get a margin call. Both initial and maintenance margin are expressed as a percentage.

What’s the difference between margin and leverage?

Margin is the amount of money you need to open a trade, while leverage is the mechanism that lets you open and maintain a much larger position with that small amount of margin. Leverage magnifies your market exposure, but it can increase both your potential gains and losses.

What is a margin call?

A margin call is like a warning triggered when your account's equity (the value of your funds, including any unrealised gains or losses) falls below the maintenance margin requirement. If you receive a margin call, you need to add more funds to your account or close positions to cover potential losses in order to continue trading.

How long can you trade on margin?

You can trade on margin for as long as you maintain the required margin levels and meet the broker's conditions. There’s no specific time limit for margin trading itself, but your position must be managed carefully to avoid a margin call. If your equity falls below the required maintenance margin, you may need to deposit more funds or close some positions.