Leverage and risk
Trading FX & CFDs on margin carries a high degree of risk because it allows you to speculate on currencies, commodities and indices on a highly leveraged basis. A small adverse price change to the underlying asset can magnify the impact on the funds in your account, potentially resulting in the total loss of your initial investment and any additional funds that you may deposit to meet margin calls.
You have USD $2,000 cash in your FX & CFD account. You buy 30,000 units of EUR/USD at 1.3000. The USD value of this FX position is ($1.3000 x 30,000=) $39,000. At a margin rate of 3%, the margin requirement is ($39,000 x 3%=) $1,170. Note that you have leveraged your initial margin deposit by a factor of 19.5 as you control an FX position of $39,000 with only $2,000 of cash.
Scenario A: market rises 300 pips to 1.3300
If the market rises to 1.3300 and you liquidate your position, you will realize a profit of 300 pips or $900. This represents a return of 45% on your initial margin deposit of $2,000.
Scenario B: market falls 300 pips to 1.2700
If the market falls to 1.2700 and you have not liquidated your position, you will have an unrealized loss of 300 pips or $900. Since your unrealized loss of $900 has exceeded the available margin of $830 (margin deposit minus margin requirement, i.e. $2,000 - $1,170), you will be required to deposit additional funds of at least $70 to cover the margin shortfall.
What is the risk?
The risks associated with margin trading are primarily over-leveraging and lack of risk management. Trading in such a manner can quickly lead to significant losses and even account liquidation.
In Scenario B, you will face a margin call when EUR/USD has fallen to 1.2724.1 If you do not meet the margin call within the specified deadline, Questrade will liquidate your position. You could also face immediate liquidation even before the specified deadline if your margin balance (equity) falls below 50% of the total margin requirement for all open positions in your account.
In this instance, immediate liquidation will occur when EUR/USD has fallen to 1.252832, leaving only $585 in your account. You will have lost $1,415 or 70.75% of your initial investment of $2,000.
Potential slippage in live trade execution may increase losses.
Please review the Questrade margin call policy.
You have USD $2,000 cash in your FX & CFD account. You buy 2 contracts of SPX500 at 1,500. The USD value of this CFD position is (1,500 x $10 X 2=) $30,000. At a margin rate of 4%, the margin requirement is ($30,000 x 4%=) $1,200. Note that you have leveraged your initial margin deposit by a factor of 15 as you control a CFD position of $30,000 with only $2,000 of cash.
Scenario A: market rises 50 points to 1,550
If the market rises to 1,550 and you liquidate your position, you will realize a profit of 50 points or $1,000. This represents a return of 50% on your initial margin deposit of $2,000.
Scenario B: market falls 50 points to 1,450
If the market falls to 1,450 and you have not liquidated your position, you will have an unrealized loss of 50 points or $1,000. Since your unrealized loss of $1,000 has exceeded the available margin of $800 (margin deposit minus margin requirement, i.e. $2,000 - $1,200), you will be required to deposit additional funds of at least $200 to cover the margin shortfall.
In Scenario B, you will face a margin call when SPX500 has fallen to 1,460.3 Furthermore, your account will be flagged for immediate liquidation if your margin balance (equity) falls below 50% of the total margin requirement for all open positions in your account. This will occur when SPX500 reaches 1,430,4 at which point you will have lost $1,400 or 70% of your initial investment of $2,000.
Potential slippage in live trade execution may increase losses.
Understand your market
It is important to understand the different characteristics and drivers behind the volatility for each market. You can gain valuable insight from reading the commentary from FOREXInsider, and monitor the calendar and news to stay informed about market events. These are available from the Trader ToolKit.
You should understand your risk appetite and your emotional response to profit, loss and volatility. FX & CFD trading is not suitable for risk-averse individuals seeking security of capital.
Monitor your positions
Be diligent in monitoring your open positions and observing closely the impact of volatile market conditions on the equity in your account. Adjust your position sizes accordingly.
Stop and limit orders, trailing stop orders, contingent orders and the ability to hedge are risk management tools to help you manage the risk of your market exposure. You should note that risk-reducing strategies can help you manage risk but not eliminate risk, and such strategies may not be effective under extreme market conditions.
Before trading FX & CFDs in a live account, beginner traders should practice with a demo account to become familiar with market conditions and trading tools without risking real funds. When ready to go live, beginner traders should test their strategies and methods by trading smaller contract sizes where possible.
This will provide you with valuable experience and exposure to live market conditions before taking on more risk or graduating to more complex products and markets. Please contact Questrade for information on available training courses offered by third-party providers.
We also encourage you to carefully read the Risk Information Document for Derivatives.
1 With a margin deposit of $2,000 and a margin requirement of $1,170, the amount of free margin is $830. The position size of 30,000 units of EUR/USD means that each pip is worth ($1 x 3 =) $3. A margin call will occur when the market reaches 1.2724, after an adverse (lower) move of about ($830/$3=)276 pips.
2 When the account is flagged for immediate liquidation there is a total loss of $1,415 which represents a –70.75% return on the initial margin deposit of $2,000. Since 1 pip of a 30,000 EUR/USD position is worth $3, immediate liquidation will occur after an adverse (lower) move of about ($1,415/$3)=472 pips from the opening price of 1.3000 when the market reaches 1.25283.
*Trading in derivatives, including FX & CFDs, involves substantial risk of loss and is not suitable for all investors.
±Questrade is compensated for its services from the bid-ask spread.