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MB Wealth Corp. is not responsible and does not endorse anything outside of the content of this article authored by Matthew Bradbard; President of MB Wealth.
In the current Wild West trading environment, where 5% price swings have become commonplace, avoiding margin calls is a bigger challenge now than what I’ve ever seen in my career. Traders can take all the necessary steps and still there is still no assurance that a margin call can be avoided, here are some suggestions that may aid in deterring future margin calls when trading commodities.
Let me start by explaining exactly what a margin call is; a call from a clearinghouse to a clearing member, or from a broker or firm to a customer, to bring margin deposits up to a required minimum level. When the balance of the account drops below the maintenance margin level a margin call is issued. Once a margin call is issued the party receiving the call generally has 48-72 hours to bring their account balance back above the initial maintenance amount. If you wish not to satisfy the margin call the alternative is liquidating the position and taking the loss.
Moving onto margin; the amount of money deposited by both buyers and sellers of futures contracts and by sellers of options contracts to ensure performance of the terms of the contract. The margin in commodities is not a down payment, as in securities, but rather a performance bond. For every commodity there is an initial margin and a maintenance margin determined by the exchange that the underlying commodity trades on. For example, when trading 30-yr bond futures, margins are set by the CME Group, while when trading cotton futures margins are set by ICE.
The leverage involved when trading commodities can at times be massive; by definition leverage is the ability to control large dollar amounts of a commodity with a comparatively small amount of capital. Leverage is a double-edged sword working as your best friend when properly positioned and your worst enemy when positioned incorrectly. Because the leverage at times can appear excessive, a possible solution would be to not over leverage one’s trading account. For example if the initial margin amount for one Crude oil futures contract is $5,000 then in your mind you should allocate $10,000 to mitigate extreme swings in you trading account. When trading commodities be selective and don’t think that all the money in your trading account needs to be allocated at all times. I try to trade a very aggressive asset class conservatively…which is easier said then done.
Other possible solutions include, but are not limited to: trading mini-futures contracts, decreasing one’s trading size, purchasing options, or a trading strategy that utilizes a combination of options and futures. Stop loss orders should also be incorporated whether they are entered when establishing a position or as a trader using mental stop loss orders, my suggestion is to always have some sort of exit strategy in case the trade goes awry. Stop orders are defined as an order that becomes a market order when the futures contract reaches a particular price level. A sell stop is placed below the market; a buy stop is placed above the market. Though stop loss orders can mitigate loss, there is no guarantee that the precise stop levels will be the price executed at as occasionally the market conditions do not allow. For example, if a market were to gap higher or lower or a lock limit move in the underlying commodity occurs. One such example several years ago that I clearly remember was a “mad cow” scare had cattle futures lock limit for several sessions. What this means is parties in the trade cannot get out of their positions regardless of whether they are short or long.
Greed and emotions are involved in any facet of trading and while trying to remove these conditions is nearly impossible, a large amount of successful traders do their best by exhibiting discipline. By that I mean not getting married to any position, cutting losses and not looking for homeruns on every transaction. The key in the long run is to be consistent and treat trading like a career as opposed to a “hobby.” Margin calls are a part of trading commodities, however to avoid this asset class all together as opposed to taking cautionary steps before initiating positions in hopes of avoiding a margin call would not be my suggestion. Remember we are human and make mistakes; the key is learning from these mishaps and to not repeat them. The current commodity market, albeit volatile, provides some of the best opportunities that I believe we may see in our lifetime.
The hope in this article was not to deter novice commodity traders but rather to inform them on what margin calls are and to be cognizant that while it is not always pleasant trading, understand that because you get a margin call it is not the end of the world. Best of luck trading!!
Risk Disclosure: The risk of loss in trading commodity futures and options can be substantial. Past performance is no guarantee of future trading results.