Shock margin hikes can hurt commodity traders

WHILE looking at trends in chart patterns is always a useful exercise when dealing with commodities, it is important that it is not the be all and end all of a trader’s strategy. Of course there are global macro influences that can drive commodity prices – copper being driven as a proxy for infrastructure building, gold as a haven currency in times of investor risk aversion being prominent examples. But commodity prices are also influenced by the internal policies of the commodity clearing houses themselves.

When a clearing house such as the CME increases its margin requirements for futures options on a commodity, it can have the effect of deleveraging that trade and triggering a sell off. Though these requirements will not necessarily affect the margin payment required from your CFD provider, they do of course affect the undelying asset on which you are taking the contract.

An example of the effect that clearing house policy can have on a commodities market can be seen from the price action following CME moves in margin requirements for gold in August (see chart, below right.) Following periods of market volatility due to haven flows into the yellow metal, the CME raised its margin requirements twice. As you can see in the chart, this triggered a gold sell off.

Given the effects that a large margin hike can have on a price, how can traders predict a margin move?

CME has stated that it has a policy of making changes in a way that they are telegraphed to the market, and in doing so give participants notice of the effects. The clearing house typically takes a mechanised approach to margins – looking at interday monitoring of market volatility. But it also takes into account qualitative factors such as seasonality and what’s in the news headlines – for example, in the past it has hiked margins on crude oil ahead of major hurricanes, aiming to reduce the risk of default by traders in the inevitable period of higher volatility.

But whatever the volatility-calming aspirations of rate setters, they do unavoidably affect prices. Especially in our current climate of big market movements. As margins are increased then traders – especially those that have been caught on the wrong side of the market – will liquidate their positions. In doing so, they exacerbate what are already big moves.

Predicting a margin hike is not an exact science. But CFD traders should be wary of one being on the horizon in a particularly volatile market. But in such a climate, they should always be analysing their exposure to all potential risk.