Prior to using a margin account, one needs to understand how margin actually works. Contrary to a common misconception, a margin account holder does not actually need to borrow funds in order to trade his account. The availability of margin can be thought of as an overdraft protection on a debit card. Although you do have a set amount of cash sitting in your account, you can chose to spend more on stock purchases. If you do not exceed the actual amount of cash that you have, you wouldn't be using margin at all and your account would behave as a cash account.

Margin can be used both on long and short positions. Although the general idea of increased leverage is similar across position types, margin calculations involved for long and short positions are significantly different. The purpose of the following discussion is to define the concept of margin and to clarify the way margin calculations are handled. The ability to understand these concepts is an imortant asset in any risk management system.

Loan Value

Definition

Loan value is a fundamental concept underlying any margin calculation. It represents the maximum amount of cash that TradeFreedom would be willing to lend to its clients using the securities in their accounts as collateral.

The loan value can be computed either for an individual position, or for the entire account. When computed for the entire account, it is the sum of all the individual loan values.

Example

Suppose the following situation:

• A margin account is opend with USD $10000.00.
• The maximum amount of cash that TradeFreedom would be willing to lend, using ABCD as collateral is 70% of the market value of the position.
• The maximum amount of cash that TradeFreedom would be willing to lend, using BCDE as collateral is 50% of the market value of the position.
• For the purposes of this example, commissions are omitted from all the calculations.

Transaction 1
 - buy 100 shares ABCD @ $25.00 against USD $2500.00
The following grid represents the situation in the account before and after the first transaction:

BALANCES

POSITIONS

Transaction 2
 - buy 100 shares BCDE @ $30.00 against USD $3000.00
The following grid represents the situation in the account before and after the second transaction:

BALANCES

POSITIONS

Implications
These examples isolate two important characteristics inherent to the concept of loan value.
 - First, the loan value can be computed both on individual positions and the entire account. As you can see, after the second transaction, the loan value for ABCD was $1750.00 and the loan value for BCDE was 1500.00. The sum of these two values gives the overall loan value for the account, which is equal to $3250.00.
 - Second, the loan value does not represent the amount of funds that has actually been borrowed. As you can notice, although both of the positions above do have a loan value, no actual borrowing had taken place in the account. By reading the first column of the second "Balances" table, you can verify that the cash balance in the account remained positive after both transactions at $4500.00.

Limitations

Overnight CAD

Overnight USD

*  Due to risk management requirements, intraday loan rates may be more stringent than those set by the IDA.

** For marginable securities trading between $2.00 and $5.00, individual arrangements can be made in order to make intraday margin available. These trades require broker assistance and decisions are made on a case by case basis.

Margin

Definition

Margin is the difference between the market value of the security being bought and the maximum amount of cash that the broker is willing to lend, using that particular security as collateral.

In order to compute the value of margin, the following formula needs to be used:

The value of margin for the entire account is the sum of the margin values computed for each one of the positions held within the account.

Example

Suppose the following situation:

• A margin account has a long position of 1000 INTC
• INTC is eligible for a loan value of 70%.
• The current market price INTC is trading at is $25.00 per share.

Consequenly, the current market value of the position is $25000.00.

Therefore, by definition,
      Margin = Market Value - Loan Value
      Margin = 25000.00 - 17500.00
      Margin = $7500.00

Now, suppose a margin account with two positions: long INTC @ 25.00, and long MSFT @ 30.00.
Both INTC and MSFT are eligible for a loan value of 70% and the market values of these positions are respectively $17500.00 and $21000.00.

Then, by definition, margin on INTC is $7500.00 ($25000.00 - $17500.00) and margin on MSFT is $9000.00 ($30000.00 - $21000.00)
Fianally, the value of margin for the entire account is the sum of these two amounts, or $16500.00.

Interpretation

The best way to interpret the concept of margin is to draw a parallel between the term margin and the term down payment. In essence, although used within two different frameworks, both of these terms refer exactly to the same thing.

Within the framework of the home equity loan industry, banks do not commonly approve clients for mortgages without requiring an upfront payment, in cash, equal to a certain percentage of the retail value of the property. In that case, the real estate property serves as a collateral for the loan and the upfront cash amount is commonly referred to as a downpayment.

Within the framework of the securities industry, the same concepts apply. Instead of the house, you are buying a security. That security serves as a collateral on your loan, and, in order to qualify for the loan, you need to maintain a certain percentage of the market value of that security in your account in the form of cash. The cash amount that was refferred to as a down payment in the case of a mortgage, is called margin within the securities industry setting.

Margin Requirement

Definition

Margin requirement is a number, assigned to each individual security, that specifies the minimum percentage of its market value that needs to be kept within the account under the form of cash, in order to maintain a position in that security.

Example

In the case of the previous example, margin requirements on INTC and MSFT were 30%.

The following picture is an actual screen shot of a hypothetical margin account. The positions section of our website gives you the possibility to read the values of margin requirements computed for every individual position held within the account directly off the screen.

As you can see, the account in question has two positions: 1500 shares of BLD and 3600 shares of CUX. The respective market values of these two positions are CAD $14025.00 and CAD $25668.00. Finally, the column named "Margin Req." indicates that the margin requirement for BLD is 4207.50, and the margin requirement for CUX is 7700.40. You can verify that both of these numbers represent 30% of their respective market values.

Interpretation

In essence, a margin requirement on a given security simply states the value of margin for which that security qualifies.

Relationship Between Margin Requirement and Loan Value

Margin requirement is usually expressed either as a percentage of the market value of the security or, as it is the case on our website, as an absolute value equivalent to a certain percentage of the current market value of the security.

By definition of margin, margin requirement on a security is a function of the maximumum amount of cash that a broker would be willing to lend to the trader, using that security as a collateral. In other words, it is a function of the loan value for which that security qualifies. The relationship that links the margin requirement to the loan value is:

Excess Margin

Definition

Excess margin is the amount by which the cash value of an account (equity) exceeds the account's margin.

The mathematical definition of Excess Margin is:
     Excess margin = Equity - Margin

Remember that:
     Margin = Market value - Loan Value

Therefore:
     Excess Margin = Equity - (Market Value - Loan Value)
     Excess Margin = Equity - Market Value + Loan Value

Now, notice that:
     Equity - Market Value = Cash

Consequently:
     Excess margin = Cash + Loan Value

Example

The following picture is an actual screen shot of the same margin account that was used to illustrate the concept of "Margin Requirement" above. The difference is that, instead of individual positions, that section provides overall information on the account's balances.

As you can see, by reading the first line of the "Equity" column, the Canadian side of that account is worth CAD $10600.02. The US side contains USD 101.81 and will not be considered for further calculations.

In a similar fashion, by reading the first lines of the respective columns, you can obtain the two remaining terms of the first equation. In effect, as you can see, the total market value of the securities held within the account is CAD $39693.00 and the loan value for which these securities are eligible is CAD $27785.10.

Therefore, by defintition,
     Excess Margin = Equity - Margin = Equity - (Market Value - Loan Value)
     Excess Margin = 10600.02 - (39693.00 - 27785.10)
     Ecxess Margin = -1307.88

Interpretation

Excess margin is a simple and yet very important concept. It is especially powerful when used for the purposes of computing buying power and issuing margin calls.

As follows from the second equation, an easy way to determine excess margin is by noticing that it is, in fact, the amount by which the loan value differs from the amount of cash that has actually been borrowed. You can see how much money you have borrowed by consulting the "Balances" section of our website. A negative value for "Cash" gives you the amount that you have borrowed; a positive value, indicates that your account has excess cash.

The second equation also makes it easier to grasp what excess margin represents intuitively. In effect, it can be viewed as the maximum available amount of cash that could be used to provide margin for future positions in securities. Hence the term "excess margin".

The resources that constitute that "available cash" are made up of two portions: the cash held within the account and the amount of cash that the broker would be willing to lend to the account holder using the securities held within his acount as collateral.

In general, if an account has a negative cash balance, then some of the amount that was available for borrowing has already been used. If the amount of borrowed cash exceeds the account's loan value, that is the amount that was originally available, then the account holder has borrowed too much cash and his excess margin will yield a negative value. In that case, a margin call will be issued.

Margin Call

A margin call is an official warning, issued by the broker, with the purpose of letting the client know that the account under his responsibility does not have enough excess margin to maintain 100% of current positions.

That situation occurs when the actual amount of borrowed funds within an account, exceeds the the maximum amount of cash that the broker would be allowed to lend using the securities held as collateral.

At any point in time, it is very easy to determine whether an account is under the margin. All that needs to be done is to consult the balances section of our website. If the "Exces Margin" column yields a negative value, then the account in question is under the margin by the corresponding amount.

Please note, that when we issue a margin call, we do not use excess margin values for individual subaccounts. Instead, we aggregate all these numbers and take the final consolidated amount in Canadian dollars. In the case of the previous example, the amount of the margin call appears in either one of the last two lines of the Excess Margin column. The one that appears above is expressed in Canadian dollars: CAD $ 1178.43. The one that appears below is expressed in US dollars: USD $926.80.

Buying Power

Definition

Buying Power is an estimate of the maximum market value of the securities that can be maintained within an account given its current level of excess margin.

Example

Suppose the following situation:

• A margin account is opened with USD $10000.00 in cash
• The original buying power available for securities eligible for reduced margin is around 33333.33, as 10000.00 represent 30% of 33333.33.
• Being optionable, INTC is elgible for a reduced margin of 30% (70% loan value).
• The current market price INTC is trading at is $25.00 per share.
• Commissions are excluded from all the calculations.

Transaction 1
 - buy 1000 shares INTC @ $25.00 against USD $25000.00
The following grid represents the situation in the account before and after the first transaction:

BALANCES

POSITIONS

Calculations
   1. Cash = 10000.00 - 25000.00 = - 15000.00
       The sale of 1000 shares of INTC at $25.00 costed $25000.00. Therefore, that is the amount by which the original cash balance needs to be reduced.
   2. Market Value = 0 + 10000.00 * 25.00 = 25000.00.
       After the first transaction, the Market Value of the securities held within the account increased from 0 to 25000.00.
   3. Loan Value = 0 + 25000.00 * 0.70 = 17500.00
       After the first transaction, the value of the securities held in the account increased to $25000.00. According to the regulaitions, the broker is allowed to loan up to 70% of the market value of a marginable security such as INTC. Therefore, in this case, 70% of 25000.00 is 17500.00, which the amount of funds that the broker would be willing to lend using INTC as collateral.
   4. Excess Margin = - 15000.00 + 17500.00 = 2500.00
       Remember that Excess Margin = Cash + Loan Value. Therefore, after the first transaction, $2500.00 are available to serve as collateral on future purchases of securities.
   5. Buying Power = 2500.00 * 3.33333 = 8333.33
       Buying power is an approximation of the market value of marginable securities that can be purchased using the remaining excess margin as collateral. Therefore, in order to determine its value, it is sufficient to determine a number x such that 2500.00 represents 30% of x. That is done by multiplying 2500 by 3.33333 (10/3).
   6. Equity = 10000.00 + 0 = 10000.00
       Equity remains the same since the price of the security did not change and commissions are not taken into account for the purposes of the present example.

Please, note that the value of buying power, which appears on this website is determined based on values accurate as of the previous trading day. On TradeFreedom Navigator, the morning buying power is updated throughout the day to reflect intraday transactions.

Interpretation

In general, buying power represents the amount of cash that can be spent before a given account drops below the minimum margin requirement.

A quick and easy way to interpret that number is to think of it as of a sort of an electronic wallet that becomes depleted as you buy more and more securities.

Although that interpretation might work in certain situations, one needs to realize that buying power is a dynamic number that varies based on several variables. The tips presented below should illustrate the impact of the main ones.

Buying Power Tips

The first general idea that anybody, using our trading system, needs to understand about the concept of buying power is the fact that the number that appears on TradeFreedom Navigator is only valid for securities eligible for reduced margin: the ones that qualify for a maximum loan value of 70% (refer to the table above).

In other words, that number is only valid for US stock issues eligible for options and Canadian stock issues appearing on the IDA list of securities eligible for reduced margin.

For all other securities, the actual buying power available to the pesrson placing the trade will be significantly inferior to the number that appears in the "Balances" section of TradeFreedom Navigator.

For example, if your account has USD $10000.00 and your intention is to buy 20000 shares of a stock ABCD trading at $1.00 on NASDAQ, and not eligible for options, the system should not be expected to accept an order simply because the buying power that appears on the screen ($33333.33) exceeds the current market value of 20000 shares of that stock ($20000.00).

Because ABCD is not a marginable stock, the account holder would be required to pay cash for any long position the he opens. The bottom line is that the buying power for non marginable stocks is 3.33 times less than the value that appears on the screen.

The same idea applies for stocks eligible for a loan value other than 70%. In general, if a security qualifies for a loan value inferior to 70%, the buying power available for that particular security will always be inferior to the one that appears on the screen. At the same time, it will always exceed the buying power for non marginable securities.

Because buying power is only an estimate, it can never be exact. Many factors influence the actual value of buying power, and it is practically impossible for an intraday trading system to show the exact value on a continuous basis. The only time when the estimated buying power approximates the actual value to the dollar is in the morning, before the markets open. But even then, currency rate fluctuations intervene to distort the picture.

Although TradeFreedom Navigator does a good job in approximating intraday buying power fluctuations, one should never blindly trust the number that appears on the screen. Errors do happen and it is up to the account holder to know where he stands in terms of buying power.

If you ever find yourself in a situation when you think that your buying power is inflated, please do not use it unless one of our representatives confirms you that your buying power is correct. If you do use that extra buying power, you might find yourself in an under the margin situation and you will be forced to cover the margin call, by bringing the account on side. If you think that your buying power is to low, please give us a call so that we can adjust it manually.

In order to open a short position, an account holder needs to sell units of a security that he does not own, with the purpose of buying them back at a lower price.

Not all securities can be sold short. Because from the trading side, selling short implies borrowing a certain number of shares of a security from the borker, it might not always be possible to execute the trade. In effect, if the broker does not have these shared in his inventory, he won't be able to lend them to the client.

The TradeFreedom Navigator offers an easy way to know whether a given security is shortable. Within the order entry box, you'll find a coloured letter "M" that appears in green when the security is marginable and in red when it is not marginable. If you point your mouse cursor on that letter, a message will pop up letting you know whether the security is marginable or shortable.

Please, note that sometimes our inventory may become depleted during the course of the day. In that case, the system will not recognize the change and will continue to show the security as being shortable. That happens because the information regarding shortability is only updated once a day, at the beginning of each trading session. Therefore, it is possible that, from time to time, the system will not let you short a security that appears as shortable. Additionally, TradeFreedom Navigator won't allow you to short any security trading below $5.00.

On the accounting side, once the short sale is executed, the seller's account receives a cash credit in the amount of the net value of the trade (book value minus commissions). Although, technically, that cash belongs to the account holder, it is not eligible for withdrawal or for payment of credit interest, as it serves the purpose of garanteeing the short position, which, eventually, will have to be covered.

Since selling short does not involve any outlay of cash, margin on short positions cannot be considered as a down payment on a loan. Instead, it is rather a protection against higher risks associated with short positions.

Theoretically, the strategy of selling short has an unlimited risk profile. In effect, the stock can rise to the infinity and the trader might incur unlimited losses. In order to temper that risk, investment dealers in Canada are required to freeze a certain amount of cash in their clients' accounts each time they sell short.

In Canada, the amount of cash that investment dealers are required to freeze on short positions are determined by the IDA. It is computed as a percentage of the market value of the security. The following grid presents the current margin requirements on short positions enforced by TradeFreedom:

Overnight CAD

Overnight USD

Although the mechanics of margin calculations are different on long and short positions, the way buying power behaves is, in fact, very similar.

Suppose the following situation:

• A margin account is opened with USD $10000.00 in cash
• The original buying power available for securities eligible for reduced margin is 33333.33
• INTC is elgible for a reduced margin of 30% (70% loan value).
• The current market price INTC is trading at is $25.00 per share.

Transaction 1
 - sell short 1000 shares INTC @ $25.00 against USD $25000.00
The following grid represents the situation in the account before and after the first transaction:

BALANCES

POSITIONS

Calculations
   1. Cash = 10000.00 + 25000.00 = 35000.00
       The cash balance went from $10000.00 to 35000.00 since the sale of 1000 shares of INTC at $25.00 brought in $25000.00 of additional cash.
   2. Market Value = 0 - 25000.00 = - 25000.00.
       The Market Value is a negative number because the account holder owes $25000.00 worth of stocks to the broker.
   3. Loan Value = 0 - 25000.00 * 1.3 = - 35000.00
       According to the regulaitions, the broker needs to freeze a certain percentage of the market value of the security involved in every short sale (refer to the table above). In the case of the previous example, the requirement is 130%, which amounts to 35000.00. In essence, having the broker freeze $32500.00 worth of cash belonging to the client is equivalent to the client's lending these funds to the broker. Hence the negative loan value in the case of a short position.
   4. Excess Margin = 35000.00 + (-32500.00) = 2500.00
       Remember that Excess Margin = Cash + Loan Value. That formula works both on long and short positions.
   5. Buying Power = 2500.00 * 3.33333 = 8333.33
       Buying power is an approximation of the market value of marginable securities that can be purchased using the remaining excess margin as collateral. Therefore, in order to determine its value, it is sufficient to determine a number x such that 2500.00 represents 30% of x. That is done by multiplying 2500 by 3.33333 (10/3).
   6. Equity = 10000.00 + 0 = 10000.00
       Equity remains the same since the price of the security did not change and commissions are not taken into account for the purposes of the present example.