A portfolio margin is a critical requirement for making sure that those who invest in risky outcomes have the money to back up their trades. The common definition of the portfolio margin relates to contracts like futures and derivatives, but the concept of a portfolio margin can be applied to any kind of trading. The margin is the capital held against risk, and a brief look into common trading strategies will show why a portfolio margin is so important.
A look at portfolio margin could start with considering the idea of leverage. Many derivatives contracts, which are complex financial instruments based on certain market outcomes, are highly leveraged. A leveraged investment is one that is designed to turn out more gain or loss than the regular market trade would provide. That means that traders can access more risk with a set amount of capital.
In recent years, the U.S. government created portfolio margin requirements for American traders to make sure that those who dabbled in derivatives and similar contracts had the money to back up losses. The portfolio margin is a major safeguard for risky investing in many different sectors. In derivatives and futures trading, the margin is an amount based on all open long and short positions. What happens with these complex trades is that a trader can place simultaneous trades on both a gain and loss of value for a particular equity or bundle of equities. That can decrease the margin requirement, since some of the trades balance each other out, making a natural hedge against some market risks.
In regular stock trading, brokers and others also refer to a “margin.” Those who trade without available capital are said to be “buying on margin.” The classic definition of this trading is that the trader will be borrowing money from the broker in order to trade. Brokers have strict rules on margin trading, and many finance pros warn investors against going this route, since it impairs their ability to buy and hold through stock losses.
The general idea of a portfolio margin works similarly to the idea of simple budgeting. The trader or investor should have funds to cover any potential losses, rather than being exposed to financial danger if certain deals don’t go his or her way. Beginners can learn a lot about finance from learning about how a margin is used, and how the idea of a margin drives modern financial policy.