Last Updated on 31 March, 2021 by Samuelsson
Some futures traders don’t like the concept of margin even though they know it can help them improve profit. The idea of getting a margin call, whereby the trader is required to deposit more money or get their trade closed at a huge loss, can be scary. So, you may be wondering if you can trade without margin.
Yes, you can trade futures without margin. What it requires is to have more than the normal worth of the contract in your trading account — for example, trading one standard contract for a contract that is worth $100,000 when you have $100,000 or more in your account. However, trading with margin allows you to optimize your contract size to make more money per trade — but that also comes with more risk.
In this post, we will discuss the following:
- What margin is in futures trading
- What it means to trade without margin
- Why you can trade futures without margins
- How to use margins in futures trading
- The benefits of margin and leverage in futures trading
- How to manage risk when trading with leverage
- What happens when your account falls below the minimum margin requirements
- Whether there’s any minimum capital requirement for futures trading
What is margin in futures trading?
The concept of margin is closely related to leverage such that you cannot discuss one without referring to the other. While margin is a good-faith deposit a trader needs to have in their trading account to control a futures contract, leverage refers to the multiple of the margin the trader needs to borrow from the broker to be able to carry the contract.
Margin can be expressed as an absolute value, but it is often expressed as a percentage of the total contract size. For example, a standard contract of EUR/USD futures worth about $100,000 may require a $5,000 margin, which can be expressed as a margin rate of 5%. In this case, the leverage is x20 ($100,000/$5,000), which means that the trader needs 20 times the required deposit to carry the contract.
In the futures trading world, the margin rate for a typical futures contract varies between 3% and 12% of the total contract value, and these rates are determined and set by the futures exchanges. However, most times, futures brokers will add an extra premium to the minimum exchange margin rate to help reduce their risk exposure. The futures exchanges set the margin based on the risk of market volatility, such that when market volatility is higher, the margin rates rise and vice versa.
So far, what we have explained is the concept of the initial margin. But there is another type of margin called the maintenance margin. While the initial futures margin is the amount of money that is required to open a position on a futures contract, the maintenance margin is the minimum amount of money that must be maintained in an account with an active losing position at any given time. It is often expressed as a percentage of the initial margin (say 40%, for example). If the amount in your account with open positions falls below the maintenance margin, the broker may do any of the following:
- Give you a margin call, requesting that you add more funds immediately to bring your account back to the initial margin level.
- Close some of your positions, if you cannot meet the margin call, to ensure that the amount in your account can carry the remaining open positions, and as the account’s equity drops further, more open positions are closed.
- Liquidate all open positions at once.
What it means to trade futures without margin
As we stated earlier, you can trade without margin but that would require you to have a huge fund in your account, big enough to carry all the positions you want to open without the use of leverage. In other words, you must have enough funds that can cover the total worth of the number of contracts you open in your trade.
As an example, let’s look at the contract value of the EUR/USD Forex futures for different contract types:
- Standard contract: Assuming the worth of one standard contract size of EUR/USD futures is $100,000, if you have $100,000 or more in your trading account and trade only one contract, you are trading without margin. If you want to trade two standard contracts at once, you must have at least $200,000 in your account. In other words, you are on a leverage of 1:1, so whatever profit or loss the contract makes in the market is what you get in your trade — it is not magnified by any leverage.
- Mini contract: For this EUR/USD futures, one mini contract size will be worth $10,000, so if you have at least $10,000 and trade only one mini contract at a time, you are trading without margin (without leverage). To trade five mini contracts simultaneously, you should have at least $50,000.
- Micro contract: The micro contract size of this futures product will be worth $1,000. Hence, if you are trading only one micro contract when you have just $1,000 in your trading account, you are trading without margin. If you have a $5,000 account, you can trade up to five micro contracts.
Why you may want to trade futures without margin
Of course, trading without margin requires you to have an enormous account size to be able to cover the complete worth of the contracts you want to trade without borrowing from the broker. In essence, you deny yourself the benefits of trading with the broker’s money and maximizing your profits. However, there are reasons why you may want to trade futures without margin, and they include the following:
- There is no rule against it: Since there is no rule against having the complete worth of a futures contract and trading just that contract size, you may as well prefer to trade that way, especially if you are the conservative type who prefers to have smaller profits and avoid huge losses.
- It reduces risks: By completely removing leverage from your trades, trading without margin ensures that your risk exposure to the market is kept low. You can only lose what the market loses and not multiples of it as is seen in leveraged trading.
- No fear of frequent margin calls: When you are trading without margin, it is nearly impossible to get a margin call because the broker doesn’t lend you the money. Since the broker’s money is not on the line, they are not afraid of losing, which is what margins call is meant to prevent. Moreover, you can only lose the entire trading capital when the asset’s value comes down to zero dollars.
How to use margins in futures trading
Despite the benefits of trading without margin, almost all futures traders make use of margins in their trading because it helps them to free up capital to carry other contracts or invest in other assets. If you want to trade futures with margin, here is how to go about it.
Open a trading account with your preferred futures broker: The first thing is to open a trading account with a futures broker of choice. Check the broker’s margin policy — both the initial and maintenance margins — before opening an account; some brokers require a higher margin than stipulated by the futures exchange.
Choose the futures products and contract type you want to trade: There are different futures products and contracts with different expiration dates. You have to choose the products to trade — they could be metals like gold or platinum; agricultural commodities like wheat or corn; energies like crude oil or natural gas; equity indexes like the S&P 500 Index or Nasdaq 100 Index; or even currency futures like EUR/USD. Depending on how much you intend to start trading with, determine whether to trade standard contracts, mini contracts, or micro contracts.
Deposit enough money to cover the initial margins of the contracts you want to trade: Deposit enough money to cover the initial margin of the contracts you want to trade. Assuming you want to trade one mini contract of gold at $18,326.50 and one mini contract of WTI crude oil at $6,064, you should have at least $24,390.50 in your trading account. Normally, you should have more than that to cover transaction costs and commissions.
Start trading: Once you have deposited the necessary capital, you can open your positions in the two products: 1 mini contract of gold and 1 mini contract of WTI. As the trade progresses, you may be required to make more deposits or close one of the contracts if your account equity is dropping.
The benefits of margins and leverage in futures trading
While the concept of margin seems to be associated with increased risk, it serves an important purpose in the futures market and offers several benefits to active traders, including the following:
- A higher purchasing power: Margin makes it possible for you to control large contract sizes with little capital. For example, if a broker offers you a 5% margin, you can trade one standard contract of the WTI crude (which is worth about $60,640) with less than $3,500 in your trading account.
- Free up capital for other investments: The use of margin allows you to free up capital for other investments. For example, if you have $100,000 investment capital, instead of using the entire capital to trade one contract of an asset worth that amount, you may use only $10,000 to trade the contract (with a 10% margin) and still have $90,000 to invest in other markets, such as equities, real estate, etc.
- Responsible money management: When you are trading with margin, you tend to be more conscious of losses and try to actively manage your risks with the use of stop loss orders and other risk management methods. While you may throw a blind eye to a $5,000 decline when trading with a $100,000 account, you won’t do that on a $10,000 account.
- Market liquidity: The availability of margin makes it possible for more retail traders to participate in the futures markets, unlike in the past when it used to be the game of big institutions alone. By only requiring a fraction of the contract value as a margin, traders no longer need a six-figure account to trade futures.
- Protection: The standardized futures trade falls under the regulatory authority of the U.S. Commodity Futures Trading Commission (CFTC). Among the duties of the CFTC is to ensure that exchanges and futures commission merchants (FCMs) have the financial ability to meet their obligations. This function effectively eliminates any assumption of counterparty credit risk by the trader.
How to manage risk when trading with leverage
Definitely, leveraged trading (margin trading) increases the risk of loss. In fact, you can blow your trading account very fast — the more the leverage, the higher the risk, and the faster you can blow your trading account. The reason is simple: every negative price movement is multiplied by the size of leverage employed, so when the leverage is much, the losses can easily accumulate with every tick against your position.
To trade effectively with margin, you need to have some risk management strategies in place. The primary way to manage risk is to manage your account risk. Do not risk more than 1% of your account in a trade so that you don’t have a significant drawdown if you experience a streak of losses. So, if you have a $5,000 account, you should not risk more than $50 per trade. To translate this to your stop loss size, you have to divide by tick value and number of contracts (preferably in micro contracts).
What happens when your account falls below the minimum margin requirements?
In futures trading, whenever you have an open position, there is a level your account equity should never fall below. That is called the maintenance margin. If your account equity falls below that level, you may receive a margin call where the broker will ask you to add more funds immediately to bring the account back up to the initial margin level. However, if you do not or cannot meet the margin call, you may be able to reduce your open position in accordance with the funds remaining in your account. In some cases, all your positions may be liquidated automatically.