A strategy with the Margin Zones indicator
To date, the majority of common market instruments have a margin character. What is a margin? In short, it is a behavioural market pattern associated with the forced closure of traders’ positions. This article will explain it in detail.
We will also consider a new ATAS indicator called Margin Zones. The use of the Margin Zones indicator helps to build a trading system whose potential profit is three times higher than the potential loss. We will show at the end of the article examples of the construction of such systems.
Read in this article:
- Market marginality
- Margin risk parameters
- Set up the Margin Zones indicator in the ATAS platform with examples
- Calculation of margin zones
- The trading system
The margin is a guarantee guarantee (GC)that is required for the execution of a stock exchange transaction. When we talk about the Chicago Mercantile Exchange (CME), the margin requirements are divided:
- GC, required for intraday trading.
- GC, required for the transfer of a position by clearing.
The first GC type is determined independently by brokers, while the second is determined by the stock exchange and is usually greater than the GC of the first type.
Let’s look at an example of how the margin works with trade. For example, a trader buys 1 futures contract for corn. According to the Chicago Mercantile Exchange, a trader needs USD 1,000 to perform such a trade. This is exactly the margin taken from the stock exchange as a guarantee guarantee for a trade.
The following table shows a list of available futures contracts at the time the item was created. The Maintenance column displays the required margin amount, while the End Period column displays the due dates of the contracts.
The hedging amount is transferred from the trader’s account to the clearing account and held there until the transaction is completed.
A futures contract for maize contains 5,000 bushels of this agricultural product, which is equivalent to 127 tonnes. At the time of writing, the market cost of corn was USD 4.15 per bushel.
A simple calculation shows that the total cost of trading was USD 20,750 and only USD 1,000 was spent. The final calculation between the trading agencies shall be made at the time of the execution of the contract. Such a trade could be concluded long before the delivery of the goods. That’s why such trades are called futures (something that will happen in the future. Read more about it, what futures contracts are in detail).
The application of margin trading allows the execution of futures trades without paying the full amount of trading costs. Such a system is very profitable for real companies engaged in the production and processing of various products.
However, there are certain limitations to holding margins in the longer term. The point is that the market costs of a product are constantly fluctuating. An open position requires the availability of a sufficient hedging amount in the foreign exchange account, and the overall balance of the portfolio could both decrease and increase.
The Margin variation, calculated taking into account the cost of an open position, is responsible for a change in the total portfolio cost. When the purchased position becomes cheaper, the margin of variation becomes negative, and when the position becomes more expensive, the margin becomes positive.
If there are not enough funds in a trader’s account to hold the open position, the exchange applies risk management and can close the position. Such an operation is called a margin call and could be applied by the exchange or broker. It is a legitimate measure because the terms of closing a client’s position without their knowledge are described in the contract that is executed when a customer opens an account with their broker.
If one side of a trade is a manufacturer of a product and the other side is a processor of that product, the deal through a margin call is not inherent. They carry out forward transactions that are hedged with both money and raw materials in order to achieve a profitable price in the future or to hedge against potential risks.
The biggest risk of being closed by a margin call is that of speculators trading on the stock market to make money from the volatility of the foreign exchange instrument. The less free funds in the account, the higher the risk.
The following image shows a typical situation in which a trader speculator opened a long trade against the downward trend and got stuck in a loss. The market continues to decline and the margin of variation reduces the dealer’s free funds. The exchange or broker closes its position through a margin call and registers the trader’s loss if the free money is zero.
The margin zone in the image is marked in red. Let us agree that we would refer to the stages of closing a trader’s position through a margin call as a margin level or margin zone.
If many long positions were opened at a certain level, the fall in the price into the margin zone would trigger a wave of closing of deficit positions.
Famous bankruptcies, in which hundreds of millions of dollars in losses were incurred, occurred as a result of the forced closure of positions on the stock exchanges:
- Let us remember the story of John Rusnack, who lost 691 million dollars on the stock exchange: John Rusnack was sentenced to 7.5 years in prison, and he was also ordered to return all lost money.
- Li Quibing lost a billion dollars in copper trading on behalf of China. The fate of Li Quibing himself is still unknown.
- Nick Nilson lost USD 1.3 billion in the management of the bank’s funds. This led to the bankruptcy of a financial institution for which Nick Nilson was sentenced to 6.5 years in prison.
A modern trader must take into account the margin-specific property of the market in order not to enter the above bankruptcy list. It makes more sense to use the opening opportunities at the moment when many other traders are closed by a margin call. How? We will talk about it in the article.
2. Margin risk parameters.
For a more specific and hands-on discussion, you should understand where you can get information for calculating margin zones. As a rule, reference data from official stock exchanges are used.
As far as the CME is concerned, for each instrument, the margin requirements set out on the website www.cmegroup.com described in detail. From the main menu, select the Trading area and then select a group of instruments from the list.
For example, you have selected the foreign exchange market (FX value). This opens a table with a list of foreign exchange instruments.
We select the Euro FX futures and go to the statistical parameters page, where we are interested in two positions: contract specifications and margins.
In the Contract Specifications section, we are interested in the Minimum Price Fluctuation parameter, which specifies a minimum increase in price and its cost:
This information helps us to understand that the cost of a tick of the 6E instrument is USD 6.25.
Then we go to the Margins section, where we find information about a minimum guarantee guarantee (GC) for a contract of the 6E instrument. In our case, the GC for a contract is USD 2,000 for positions transferred overnight.
Now we have all the necessary information for the calculation of margin zones, which we can apply in the indicator margin zones.
3. Setting the margin zones
To use margin zones in our trading, we need to use the Margin Zones indicator of the ATAS platform. To add it to the chart, go to the Indicators section and click the Add button.
The indicator is displayed in the chart in the form of horizontal ribbons corresponding to different border areas. By default, the first with 25 corresponds to the entire margin zone, the second with 50 and the third with 100. The availability of the intermediate margin zones is justified by the fact that some brokers offer leverages to their clients, which shortens the distance to the margin zone.
We need to set the parameters so that the display displays the margin zones correctly. To do this, it is necessary to adjust the margin size and tick costs. We have already explained to you above where you can take this data from.
The start calculation point corresponds to the extreme points of the current week with the set parameter Auto-Calculation. You should use manual mode to set the value for the custom price from which the margin zones are formed.
The Direction of zone parameter is responsible for the direction of the zone display – up or down from the starting point. The Zone Width parameter determines the number of days in which the zones are displayed in the chart.
4. Calculation of the margins from high/low or from the volume.
The following image shows what the chart looks like with 2 indicators with different directions – up and down.
1) In the first case, the calculation of the margin zones is constructed from the maximum of the week and directed downwards.
2) In the second – directed from a minimum of the previous week and upwards.
It is one of the most widely used methods of creating peripheral zones.
Another method of creating margin zones is to assign the starting point to the levels of large horizontal volumes reflecting the activity (interest) of market participants. To identify horizontal volume concentrations, you need to add the Market Profile drawing tool to the chart (just press F3 to activate it).
Expand the market profile to the part of the chart where you have noticed a rising trend of interest. Now we see concentrations of quantities over the entire period of price increase.
We see an obvious splash of volume near price highs in point 1. We note that the base volume concentration is at the level of 1.13460 and transfer this value to the Indicator Margin Zone, which has the downward direction.
The lower point 2 is at the level of 1.11490, where we also have a volume concentration. We transfer this point to the second margin zone indicator, which has the upward direction. Now our chart will look like this:
The price broke the margin zone in point 1, and as we can see, the trading session above the broken zone was closed. Positions of sellers who were stuck in point 1 without free liquidity from the level of 1.11490 were forcibly closed. The ascending impulse was then exhausted and the downward movement began.
A similarly unpleasant situation could also be expected for buyers who open their positions from the level of 1.13460 if the price would reach the lower limit of the margin zone in point 2.
How to create more precise margins?
To do this, we would need two more indicators in the chart: Volume and Delta. It is preferable (for more comfort and less space) to combine these two indicators in one panel, as shown in the image below.
A candlestick with the above-average volume and the maximum overweight in the delta can be found in the ascending movement for the 6S instrument (CHF futures). We mark this candle as a control candle.
Then we transform the chart into cluster mode to more accurately identify the maximum volume concentration in the control candle and find the price from which we would build the Margin Zones indicator. This value is now 1.0153.
We transfer the obtained value to the Indicator Margin Zones and check the chart. The obtained margin zone at the lower end of the chart served as a very strong level of support, from which the correction to 1/4 and 1/2 of the margin zones (MZ) was developed.
Trading system based on margin zones
The unloading of margin positions that are stuck in losses releases large volumes, the balance of changes in demand and supply, and the major players enter near-margin zones. All these interconnected events often lead to a market reversal and the emergence of a new trend.
Taking into account the market margin, we can build a trading system based on breakout/bounce from margin levels.
As an example, we assume that the outbreak of margin levels leads to a redistribution of profits and losses among market participants. When some of the open positions are forcibly closed, interest in supporting the trend decreases. Let us try to transfer this to a trading system.
First, let’s assume that the price in the margin zones could meet with strong support or resistance. As a rule, in such situations the market is corrected. The correction can develop up to the circumference of 1/2 or 1/4 of the zone.
Such a situation looks like this in the graph:
The touching of the upper margin level from which the sale is to be opened is done under point 1. The Take Profit is published under 1/2 of the margin zone in point 2.
It is important to understand where to put a stop loss when you build your trading system. In this case, it makes sense to use the value of 1/3 of the supposed take profit. In our case, the full zone is 320 ticks, 1/2 of the zone is 160 ticks and 1/3 of 160 ticks is 53 ticks. So we set the stop loss 53 ticks above the point of opening the position. The gain in this trade is 160 points, while the possible loss is 53 points.
Let’s look at another example with the breakout of 1/2 from the margin zone.
Some brokers offer their clients leverage opportunities that reduce the risk of a margin call occurring relative to leverage size. For example, 1/2 of the leverage would correspond to 1/2 of the margin zone. In addition, the broker can close part of the loss-making position of the client if the margin of variation is half of the initial cost of trading with the opposite sign. It means a situation in which free funds in the trader’s account cover only 50 of the required GC.
The following example shows a situation in which the price moved above the broken level after the breakout of 1/2 of the margin zone.
In this case, we are waiting for the ascending movement to the next margin level to continue. We set a limit purchase order at the broken level (point 1) and calculate the stop loss according to the method described above (point 2). We get the expected gain of 163 points and a stop loss of 53 points from the entry point.
When testing the broken level, the price went down dangerously to the level of our stop-loss, but it was missing 10 ticks to trigger it. As a result, we receive the profit of 163 points (point 3).
A trader needs a clear trading system and adequate risk management if he wants to profit from trading. Margin zone trading allows that, and a acceptable risk can be added.
Let’s briefly identify the principles that can be used in the strategy of trading by margin zone:
- Edge areas can usually be support and resistance levels;
- Horizontal volume levels allow a more accurate calculation of the margin zones;
- A collapse of a peripheral zone and the fixing of the price at the end of the American session indicate a high probability of the collapse continuing towards the next periphery;
- The trading system with margin zones assumes a CRV of 3 to 1.
Download ATAS and experiment with the Margin Zones indicator right away. We wish you never to experience a margin call.