Traders use futures contracts extensively in the context of making a profit by offering trades without owning the underlying instrument. They are contracts enabling participants to take a position with regards to future price movement in commodities, stock, or index. One such often ignored factor is margin money and particularly MTF (Margin Trading Facility).
What is Margin Money?
This is the money that the trader pays initially to open a position in a futures contract. It is not a payment of the asset itself but serves the trader as a security deposit to ensure that he meets possible losses. Margin requirements are specified by the exchange but are subject to change depending on volatility, contract size, or any changes made by regulators. At all times during trade, this margin must be maintained, or the trader comes under the threat of a margin call.
The Role of MTF – Margin Trading Facility
MTF is the Margin Trading Facility that allows traders to amplify their positions by borrowing money from the brokerage. Through this facility, a trader can have a huge position beyond what his capital would have allowed. This is advantageous for the trader in terms of being able to make profits but disadvantageous since it exposes him to losses.
Effects of Margin Money on Futures Trading
Futures contracts are marked to market daily; therefore, unrealized profits and losses are adjusted in a trader’s account daily at the end of each trading day. In the case where the market is unfavorable to the trader, the brokerage may demand the deposit of funds to maintain the margin requirement. Otherwise, liquidation of the positions would occur, leading to losses that can thus be realized.
Risks Retail Traders Usually Ignore
Leverage Increases Losses
Attractiveness of futures for traders comes because they can take control of a larger position with a relatively little amount of capital. Leverage magnifies both profit and loss; being exposed to just a 1% unfavorable price change could lose a substantial amount from margin money, leading to a kind of price movement that generally traders do not prepare themselves for.
Mark-To-Market Demands Changes from Day to Day
Traders are required to mark-to-market daily and settle their net gains or losses at the end of the trading day. All retail traders may not account for this, rather thinking that with initial margin money, they can run throughout the life of the trade. But if the trader were to forget to have a look at his account on a given day, he will most likely experience a sudden margin call.
Overconfidence Induced by Borrowed Funds
MTF may be a major contributor to illusions of false security. With MTF, traders may stakeholderize, thinking that an easy top-up of margin is in the offing, or that it will not be long before market conditions change their favor again. The result is often going for even larger ones, taking on riskier proportions in the portfolio and certainly at times showing a lack of imagination in planning for worst-case scenarios.
Ignoring Volatility and Stress Testing
Maintenance of margin fluctuates according to volatility of the asset as a result of its intensive fluctuations. Most retail traders do not think about how sudden price swings or news events can increase margin requirements overnight. Without stress testing trades for extreme scenarios, one will wake up one morning to find his account suddenly drained.
Psychological Stress
Margin calls induce psychological pressure that leads traders to act outside of objectivity and to behave impulsively. They might overtrade or panic sell their positions backed heavily by their emotions without much consideration whether such actions would diminish either their profits or capital.
Leverage Limitations
Even if a brokerage offers very high leverage through MTF, its use must always be judicious. Using just a fraction of the money one could borrow keeps risk exposure under control and losses manageable during violent fluctuations in the markets.
Monitor Positions Consciously
The position should be subjected to daily mark-to-market adjustments by the account. Additional safeguards such as setting automated alerts and using stop-loss orders will also help isolate ill advised positions before heaping losses upon them.
Scenario Planning
Stress tests should be done by considering counter-scenarios given adverse price movements to see how much additional margin would be needed. This could make one better prepared for the sudden turn of things in the market.
Keep an Emergency Fund
Setting aside a margin call reserve can prevent forced liquidation. The cushion provides traders with time to assess the situation and decide whether to add funds or close positions.
Conclusion
Most retail traders underestimate margin money and MTF. Although these two tools allow a trader to make larger trades with less capital, they carry a very high risk, which must be carefully managed.
