Margin and leverage

Margin is the part of futures that new traders get wrong most often. It looks like a price tag, as if one MNQ "costs" a few hundred dollars. It doesn't. Margin is a deposit that lets you control a much bigger position, and that is where the danger lives.

In this lesson I'll walk through the types of margin, the leverage math, and what happens when an account runs dry.

Initial and maintenance margin

CME Group explains that initial margin is the amount required by CME Clearing to open a futures position. Maintenance margin is the minimum you must keep in the account while the position stays open. CME Clearing sets these amounts, and they change with market volatility.

CME also notes that margin is typically a small slice of the contract's full value, often 3 to 12 percent. Your broker may ask for more than the exchange minimum.

Day-trading margins

Exchange margins apply to positions held past the daily close. Many brokers also set their own day-trading margin, for positions you open and close within the same session. These are set by the broker, not by CME, and they can be far below the exchange figure.

A low day margin can feel like a gift. It isn't. It only means you're allowed to hold a large position with little cash behind it. If you are still in a trade near the close, the broker may require full exchange margin or close you out.

The leverage math

To see leverage, you need notional value. That's the full dollar value the contract controls: the index level times dollars per point.

Here is an illustrative example. The index level below is a round number I picked for easy math, not a current quote. If the Nasdaq-100 were at 20,000, one NQ contract would control 20,000 times $20, or $400,000. One MNQ would control 20,000 times $2, or $40,000.

Now suppose your broker's day margin on one MNQ were $100. That deposit would control $40,000 of index. That's 400 to 1 leverage. A 1 percent move in the index, 200 points in this example, would be $400 on one MNQ. That's four times the deposit, gone or gained in one move.

This is why the CFTC warns that futures traders can lose all their money and be required to pay more than they invested. With leverage, you can lose more than your account.

Margin calls and liquidation

Every day, the clearing house marks your position to the market. Losses come out of your account. If your balance falls below maintenance margin, CME says you may receive a margin call and must add funds right away.

If you can't, your position may be reduced or liquidated. For day traders, many brokers do this automatically and fast. You don't get to wait for price to come back. And if the market gaps past your account balance, you can end up owing the broker money.

This is part of why so many people lose. In one study of Brazilian index futures, 97% of people who day traded for 300 days or more lost money. Margin doesn't cause losses on its own, but it makes them bigger and faster.

The takeaway

Margin is a deposit, not a price. CME sets initial and maintenance margin, while brokers set day margins that can be much lower. Size your trades by your stop in dollars, never by how many contracts your margin allows.

Do this today

• Look up the current CME initial and maintenance margin for MNQ on cmegroup.com.
• Find your broker's day-trading margin for MNQ and write down what happens to open positions near the close.
• Calculate MNQ notional value at today's index level and compare it to your account balance.

Check yourself

Answer each one in your head, then open it to check.