Margin Trading

Margin trading is the practice of trading assets using funds borrowed from a broker. This term is also called “leveraged trading”. How does margin trading work?

Suppose, you have an initial capital that allows you to purchase 10 shares. The broker can give leverage “2 to 1” (by doubling the initial funds), and you can buy not 10 shares, but 20 ones!

Margin trading is subject to the following principles:

• Margin trading always involves using borrowed funds in addition to own capital.
• Margin loans are always secured by collateral in the investor’s account.
• A liquid asset serves as collateral for the loan.

What is Margin in Simple Terms?

The term margin can mean different things depending on the context. In general business/finance context, there is profit margin:

• Profit margin is the difference between the cost of purchasing a product and the cost of selling it.
• It shows the share of profit in revenue.
• Sometimes it is informally compared to markup (an addition to cost), but markup reflects a percentage added to cost, while profit margin shows how much profit remains from revenue.

Against, on the stock exchange, margin means collateral — a blocked amount of funds in a trader’s account. There are two main types:

• Initial margin — the necessary collateral to open a margin position.
• Maintenance margin — the minimum amount of equity required to keep a position open. If account equity falls below this level, the broker will force liquidation.

So, a trading position will be liquidated if equity falls below the maintenance margin level set by the broker. If the trader’s balance suddenly decreases during a loss-making trade, the broker will send him a margin call — a request to deposit additional funds to maintain open positions. After that, the broker will be able to liquidate some positions to cover losses. This will avoid reducing the value of the liquid portfolio (in practice — account equity) to a critical figure. The broker can close positions until the value of the liquid portfolio exceeds the initial margin.

In order not to get a margin call, you need to follow the following rules:

• Constantly monitor the market.
• Control the positions involved in the transaction.
• It is more profitable to close a losing position in order not to lose capital.
• Respond to broker’s messages in a timely manner.

Advantages of Margin Trading

• It is possible to increase profits both on the growth and on the decline of the market.
• Margin trading allows greater market exposure with the same amount of capital.
• It is possible to purchase securities against collateral.
• The efficiency is higher than only when trading with personal capital.

Risks of Margin Trading

• The higher the leverage, the greater the potential losses.
• There is a risk not only of losing your own funds, but also of owing money to the broker.
• There is also a risk of interest and financing costs charged by the broker.
• There is always the risk of losing money due to price fluctuations.

If you are an experienced player, you just need to navigate and invest on different exchanges.