Gold is no different than any other asset traded in financial markets and they are ways to buy it on margin. For instance, depending on the broker, one could buy the shares of the SPDR Gold Shares (GLD) ETF with the use of a loan from the broker. This would be margin buying. One thing to remember is that any sort of margin buying automatically implies the use of leverage. The most classic example, however, is buying gold futures.
Suppose that you want to open a long position in gold futures. Your broker requires some initial margin, say $3,000. Additionally, the broker requires some maintenance margin, say $2,500. So, you initially deposit $3,000 and open a long position in a gold futures contract. This contract gives you exposure to 100 troy ounces of gold. Suppose the price of gold stands at $1,000 per troy ounce. This would mean that the whole position is similar to a $100,000 position in gold. But you still only put down $3,000 to open it. Now, suppose that the price of gold goes down to $999. The value of the whole position is $99,900. So, the value changed by $100 and the value of your equity is depleted to $2,900 ($3,000 initial margin minus the change of $100). This is still above the maintenance margin of $2,500, so you can trade further.
However, if the price goes down to $990, then the value of the whole position is $99,000, your equity is down to $2,000, which is below the maintenance margin of $2,500. You now get what a margin call – this is a demand from the broker to supply enough funds to meet the initial margin. In the discussed case, you would have to supply an additional $1,000 in cash for the broker to keep your position open. If you fail that, then the position will be automatically closed by the broker.
There is one more characteristic of margin that any trader should know. Namely, margin requirements usually increase when the volatility in the market goes up. Let’s take a look at the chart below which features the margin requirements for silver alongside the price of the white metal in the period from January 21, 2011 to February 13, 2012. This was the period within which the long-term top in silver was formed.
If you take a look at the chart above, the margin increased from $8,250 to $18,500. The change in the margin requirement is designed to keep the leverage in reins. At the same time, however, it has negative effects for the investors that are on the right side of the market. The rising requirements make it harder for investors with profits to keep their positions open as they might get caught up in a correction when the requirement are rising. Also, you will notice that the steepest rise in the margin requirements coincides with the steepest decline in the white metal. This suggests that the rising requirements might also contribute to the inhibition of a move to the upside (in this specific case). Also, the requirements seem to persist in spite of the price going down. So, the requirements after a top are likely to be higher than before it even if the price is precisely at the same point (this is visible on the above chart). The margin requirements are something to keep in mind.
Crude Oil Margin
As far as margin trading is concerned, crude oil is no different than other commodities. Margin trading is usually linked to oil futures trading. In this respect, it is mostly the same as for gold or silver futures. An initial margin is required to open a futures position. A margin call is issued when the equity falls below the maintenance margin and the equity then has to be supplemented to cover the initial margin. The margin for oil futures is subject to the same caveats we have mentioned for silver (and which apply to gold as well).
A final note would be that margin trading involves leverage. Leverage can magnify your gains but it can also magnify your losses. Using leverage, you might risk more than your initial capital. This means that if the market is particularly volatile, you could potentially end up losing more capital than you initially put up. This should make you particularly careful when considering margin trading. In our opinion, the rule of thumb should be that you should only consider margin trading when you are absolutely sure what you are doing.
We encourage you to learn more about the gold market – not only about gold margin trading, but also how to successfully use gold as an investment and how to profitably trade it. A great way to start is to sign up for our Gold & Silver trading Alerts. If you’re not ready to subscribe yet and are not on our gold mailing list yet, we urge you to sign up. It’s free and if you don’t like it, you can easily unsubscribe. Sign me up!