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These days, utilising raising equity from a brokerage or exchange to increase original personal trading capital through margin trading with leverage is a very common practice. The variation margin, which establishes the minimal amount of money needed to keep open positions in financial assets, is one of the interrelated components that make up the intricate mechanism of the margin lending system.
This article will cover the question of what maintenance income (margin) is, what differences it has with the initial margin and on what principle it is calculated.
Maintenance margin is an absolute measure of the minimal needed quantity of capital to maintain open positions.
The variation margin is closely related to the initial margin, but there are dissimilarities between them.
What Is Maintenance Margin?
Margin, one of the fundamental concepts in the world of trading, describes the process of raising funds, for example, from a Forex broker when trading currencies or from a crypto exchange when trading virtual currencies. The term is closely related to other equally essential concepts in the world of trading, such as leverage, interest rate or short position, which together form the basic terminology used in leveraged trading.
Maintenance margin (also variation margin) is a minimum quantity of funds acting as collateral for the entity providing margin lending (stock exchange, broker), which a trader or investor must have on his margin account in order to ensure the conditions necessary to maintain already open margin positions within the framework of trading in any types of investment instruments with the help of leverage. This mechanism of operation of the margin system is universal and identical regardless of the financial market where leveraged trading exists.
The minimal variation margin requirement is a dynamic indicator of the quantity of funds (capital) needed to maintain open positions and is calculated individually for each case of using borrowed funds. This indicator, foremost, depends on the terms of lending, i.e., the level of leverage used, as well as the amount that was used to open a position. Not the least role in this case plays any type of transaction, whether it is an order to open a long position or a short one. For each case, the system automatically calculates a fixed percentage of the variation margin from the initial margin amount to give the trader an understanding of when the margin call may occur or when the position will be completely closed if they do not deposit additional funds to fix the situation.
The maintenance margin ratio reflects the correlation between the value of an open position and the level of leverage set for its opening.
Initial Margin vs. Maintenance Margin: What is the Difference?
Initial margin vs. maintenance margin: What are the distinctions between them? As mentioned above, margin is a fundamental concept of margin trading and includes various elements. In particular, the variation margin level, representing the minimum quantity of margin account value required to maintain open positions, is closely related to the concept of initial margin, which reflects the amount of cash in absolute or percentage terms required to open a position. Despite the similarity of the concepts, there are still some distinctions between them, which are presented below.
1. Limiting Maximum Leverage by Initial Margin
The first and most significant dissimilarity between initial and variation margins is that the initial margin level tends to limit the maximum amount of leverage allowed to maximise the potential for trading in the financial markets, particularly the stock market. For example, if the initial minimum margin requirement on the part of a brokerage firm or stock exchange is 50%, a trader can leverage up to 2:1. Further, as the value of investment assets in the portfolio grows, the size of the offered leverage will diminish in direct proportion to the rate of growth of their value.
In order to be able to trade with higher leverage (4:1 and above), which the variation margin will provide, a trader needs to lose a large part of his capital. As practice shows, the majority of market players, especially speculators, who utilise leverage trading, also use such tools as stop-loss and sell their assets long before such a moment.
2. Requirements Applied to Margin Amount
The initial margin requirement is specified as a percentage of the total cost of the financial assets. A minimum starting margin of 50% is required under Federal Reserve Board Regulation T to purchase stock. The stock's market value that investors obtain on margin must be covered by cash or other assets equal to at least 50% of that value. But Regulation T merely establishes a minimal threshold for margin accounts. Following stock volatility, market conditions, and other factors, stock exchanges and brokerage companies may impose higher than 50% initial margin requirements.
On the other hand, maintenance margins are represented as a percentage of the position's value. The variation margin level must be at least 25% of the total market value of the assets bought on margin, according to the FINRA (Financial Industry Regulatory Authority), which oversees servicing standards. Brokerage firms may, however, levy greater maintenance obligations, similar to the initial margin, based on several variables, such as market volatility and liquidity.
How is Maintenance Margin Calculated?
Maintenance margin is an indicator that acts as the main reference point, giving the trader comprehensive information about the state of his open positions. Since trading on financial markets, and in particular, on the cryptocurrency market, is obviously associated with risk due to the existence of high volatility of prices of different assets, the variation margin in leveraged trading reflects the degree of need to adjust the chosen trading strategy in case the chosen trading method leads to situations in which there is a liquidation of the trader's positions.
The margin lending system consists of many components, each of which equally needs to be taken into account in order to be able to correctly calculate the level of risk and debt obligations that the trader assumes at the moment of borrowing funds. Taking into account the complex mechanics of leverage in trading on all financial markets without exception, both initial and variation margins are an absolute measure for assessing the ratio of the risk level in comparison with the expected profit and the level of debt obligations to the stock exchange or brokerage house.
In order to determine the exact value of the variation margin within the framework of financial markets trading, mathematical calculations are used, which can be represented by a relationship in the form of the following formula:
VML – variation margin level;
PA – position amount;
AEP – average entry price;
VMR – variation margin rate;
ACCP - assumed commission for closing the position.
In turn, the average price of a position is calculated according to the formula below:
APP – average position price;
TCV – total contract value;
TTA – total transaction amount.
When calculating the variation margin indicator, it is also useful to know how the price corresponding to the moment when a margin call may occur is calculated. The calculation is made based on the next formula:
P0 – initial buy price;
IM – initial margin;
MM – maintenance margin.
Due to the distinct conditions of margin lending, existing within the framework of trading in distinct subjects of markets, the calculation may differ and have additional variables. This aspect is due to the fact that the mechanics of leveraged trading itself, despite the general concept, have some differences depending on what type of capital market is used, so it is necessary to take this point into account to ensure the accuracy of calculations.
Variation margin is an essential indicator that allows you to assess the state of your investment portfolio, and in particular, open trading positions, in order to ensure optimal trading conditions aimed at generating profits and avoiding unforeseen situations, including the well-known margin call and liquidation, which arise as a result of incorrectly determining the ratio of risk tolerance to the desired income.