Ever heard of the term Margin Trading, but not entirely sure what it exactly means? Then you are in the right place. In today’s post, we will be taking a look at Margin Trading, understanding what exactly margin means, how it is done, and most importantly, should margin trading be part of your trading strategy going forward.
What is Margin Trading?
To answer this question, it is best to start with the term ‘margin’. The margin represents security collateral you will need to deposit before borrowing money from the broker to trade the financial markets. Simply put, the margin is the minimum amount of funds required to open a position.
If we dig a little deeper, however, there are actually two main types of margin in trading. First, there is the required margin, sometimes referred to as a minimum equity requirement, which we have touched upon above. This type of margin is determined by the amount of leverage you have chosen when opening a position. This will be represented as a leverage ratio detailed below:
| Leverage | Margin Requirement |
| 2:1 | 50% |
| 5:1 | 20% |
| 10:1 | 10% |
| 20:1 | 5% |
| 30:1 | 3.3333% |
The second type of margin is a margin call, which is essentially a minimal amount of margin required to keep the position open and running. The broker you are trading with, will at times, depending on the trades performance, require you to cover the margin using your trading account balance to mitigate any risk or potential losses you and the broker are exposed to.
When your trade meets a certain risk threshold, you will likely be put on a margin call. This is an opportunity for you to top-up your trading account balance to keep the position open., informing you about the trade, and that if you do want to keep the position open, you will need to top-up your trading account balance, or alternatively close them.
Failure to top-up your balance or close your trade by your accord will result in the trade closing due to margin closeout.
What Are The Benefits Of Margin Trading?
More Purchasing Power
A significant advantage is even if you have a relatively small amount of capital to invest, with margin trading you can increase your purchasing power, potentially resulting in greater profits.
React To Market Movements More Swiftly
Another benefit to having increased purchasing power is the ability to act quickly to any market movement. For example, without margin trading, if an opportunity arises and you do not have enough capital to open the position, you may miss out. However, having the ability to increase your position size through leverage allows you to frequently take advantage of more opportunities.
Trading Flexibility And Diversification
Not only does it give you the power to open more trades, but it also allows you to be more diverse with your investments. Margin trading is not only about meeting the minimum margin requirement for one trade, you may find it useful to spread your capital across multiple asset classes, essentially following the not putting all of your eggs in one basket principle.
What Are The Risks Involved With Margin Trading?
Increased Exposure
By trading with leverage and margin, while it does grant you the power to make larger investments, opening larger positions, potentially resulting in larger profits, there is the other side of the coin – magnified losses. Simply put, an increased amount of reward comes coupled with an increased amount of risk.
Margin Call
A broker has to manage the risk from the capital they provided you with. Meaning, if your trade is underperforming, you will be put on a margin call, where you will need to top up your trading account balance to keep the position open. If you are not able to keep the trade open by depositing more funds, the position will be closed.
Examples of Margin Trading
In this example, let us say that in your trading account with your broker you have $20, and you are looking to open a position on a CFD stock, with a leverage of 5:1. This means that you will be able to trade $100 worth of the asset, with each dollar used from your required margin, which is with 20% of the total value of your trade. This results in the broker providing you with $5 for every $1 you put in, meaning your original $20 becomes a nice $100.
Alternatively, if you were using a 10:1 leverage (10%), it would give you the ability to trade with $200. This is due to the fact that every $1 you put in would now be represented as 10% of the total trade, resulting in you having $10 with the chosen leverage of 10:1.
And lastly, if you were using leverage of 20:1 (5%), you would then have the ability to trade with $400 using your original $20 trading account balance.
Note: Remember to check each asset’s leverage ratio or margin percentage as they will differ.
Conclusion
To summarize, trading with margin gives you the ability to increase your purchasing power, which can magnify your profits, and offer you more flexibility and diversity with your trades. However, there are two sides to the coin of trading, where there are great rewards, there also comes great risk. So if you are considering trading with margin, be cautious and always remain vigilant. Remember, you should only ever invest capital you can afford to lose.
Another important factor to consider is to prepare for a potential margin call, setting aside additional funds to cover any unforeseen events. Ultimately, as with any trade, you need to prepare for the trade with care, and then manage it effectively once the position is open, and if done correctly, you can amplify your profits.
The best way to familiarize yourself with margin trading as a beginner is to try out a demo account, in a reduced-risk environment. The best trading platforms out there usually offer such an account, as it is a great way to introduce yourself to a new aspect of trading, without losing capital.
We hope that you found this post on margin trading useful, should you have any questions regarding the above, or anything else trading-related, please do not hesitate to contact one of your account managers, who will be more than happy to help you.