Futures trading is a popular financial activity that involves buying or selling commodities, currencies, stocks, or other assets at a predetermined price and date. It allows traders to speculate on the future value of these assets and potentially profit from their predictions. One key aspect of futures trading is leverage and margin, which are essential concepts to understand before diving into the trading world. This comprehensive guide will discuss everything traders need to know about leverage and margin in futures trading in Singapore.
Leverage involves utilising borrowed capital or financial instruments to amplify the potential return on investment in futures trading. In futures trading, leverage allows traders to control a more prominent position with less capital. For example, if the margin requirement for a crude oil contract is $5,000 and the trader wants to buy ten contracts, they would need $50,000 in capital. However, with leverage, they could control the same ten contracts with less capital.
Leverage is expressed as a ratio, such as 10:1 or 20:1. Therefore, for every $1 in your trading account, you can control $10 or $20 worth of assets. The higher the leverage, the higher the potential return on investment, but also the higher the risk. It is essential to understand that leverage amplifies both profits and losses.
Singapore-based traders can access leverage up to 50:1 when trading futures on the Saxo Bank platform, which means they can control a position worth $50,000 with only $1,000 in their trading account. However, it is crucial to use leverage responsibly and not overextend oneself, as it can lead to significant losses.
Margin is the minimum amount of funds traders must have in their trading account to enter a futures contract. It acts as collateral for the borrowed funds used in leverage. The margin requirement varies depending on the underlying asset, market conditions, and broker.
In Singapore, margin requirements for futures trading are regulated by the Monetary Authority of Singapore (MAS). For example, the margin requirement for crude oil contracts traded on the Singapore Exchange (SGX) is 8% of the contract’s notional value. Therefore, if a trader wants to buy one contract worth $50,000, they would need a minimum of $4,000 in their trading account.
It is crucial to note that margin requirements can change based on market volatility or other factors. Traders must monitor their margin requirements and have enough funds in their accounts to cover any potential losses.
Initial and maintenance margin
In addition to the overall margin requirement, there are two types of margins involved in futures trading – initial and maintenance. The initial margin is the minimum amount of funds needed to enter a futures contract, while the maintenance margin is the minimum amount required to keep the position open.
When traders enter a futures contract, they must meet the initial margin requirement. If their account falls below the maintenance margin level due to market fluctuations, they may receive a margin call from their broker. A margin call requires traders to deposit additional funds into their trading account to bring the margin level back to the initial requirement. Failure to do so may result in forced liquidation of their position.
It is crucial to understand and monitor both initial and maintenance margins, as they can significantly impact traders’ positions and overall profitability.
The benefits and risks of leverage
The primary benefit of leverage is controlling a more significant position with less capital, potentially increasing profits. It also allows traders to diversify their portfolios and enter multiple positions with different underlying assets.
However, leverage comes with significant risks. A slight market movement can result in substantial gains or losses, depending on the leverage used. Traders must have a solid risk management strategy and use leverage responsibly to mitigate potential losses.
Traders must also consider the financing costs associated with leverage, such as interest fees, which can impact their profitability.
Margin requirements for different assets
Margin requirements vary depending on the underlying asset’s volatility, liquidity, and market conditions. Generally, more volatile assets require higher margins to cover potential risks adequately.
For example, margin requirements for stock index futures are typically lower than those for currency futures, as stock index futures tend to have less volatility. On the other hand, energy and agricultural commodity futures may require higher margins due to their volatility.
Traders must familiarise themselves with the margin requirements for different assets to make informed trading decisions.
Risk management strategies
Proper risk management is crucial when trading with leverage and margin. Traders must have a solid understanding of their risk tolerance and use appropriate strategies to protect their capital.
One common strategy is setting stop-loss orders, which automatically close out positions if they reach a certain loss percentage. Another approach is diversifying portfolios by entering multiple positions across different assets, reducing the overall risk.
Traders must also regularly monitor their margin requirements and have enough funds in their accounts to cover any potential losses. It is essential to avoid overleveraging and trading with money they cannot afford to lose.