Margin trading

DEFINITION of Margin trading

Margin trading is a kind of speculating on financial markets that involves extending your exposure using leverage.

WHAT IT IS IN ESSENCE

Leverage is an ability that enables you to open a position on a market without needing to put up the total value of your position.

Instead, you only need to put up a deposit known as a margin, and your provider loans you the rest. This margin can be settled later when you square off the position.

With margin trading, you can buy a big lot of shares despite not having enough funds to afford the same by borrowing the funds from your broker.

This can be done by paying a margin, which is a small part of the total value of the shares bought.

If your profit is higher than the margin then you make a profit, if it isn’t, you lose money.

Similar to the concept of margin trading, you can also buy stocks on margin. In this case, the stocks or securities which you buy act as the collateral. Of course, you have to to pay the margin amount, which is a percentage of the total value of the order and the minimum margin while opening the margin account.

Based on the credit replayability, the minimum margin and maintenance margin values are decided. In case the value of stocks falls below a minimum margin. Your broker would ask you to maintain the minimum balance of your margin account. You could do this by depositing additional cash or by selling the securities to compensate the amount.

You can trade on margin using leveraged products, such as CFDs and spread betting.

HOW TO USE

When you open margin trade, you’ll only have to put down a deposit: a percentage of your position’s full exposure.

For example, if you want to open a position on $2000 worth of shares and your provider has a margin requirement of 10%, the initial capital you need is $200.

Once your trade is open, you must then maintain a minimum amount of cash in your account to keep your position running. If the balance of your account falls below this maintenance margin, your provider would then ask you to increase the funding in your account. This is known as a margin call.

While margin trading can increase your profits, but it can also lead to extend losses.

How does it happen?

Your profit or loss is calculated using the full value of the position, not just the margin. Say the market moves against you. Now it is important to be aware that your losses could exceed your initial outlay.  

Let’s take our above example.

If your $2000 worth of shares rose to a value of £2400, then you would have made $400 and double your initial outlay. But if the shares had fallen to $1600 instead, then you would have lost $400, again double what you originally put down.

There are numerous ways that you can manage your risk and limit your potential loss. Stops and limits will automatically close out your trades at the level you decide. To preventing running losses, or locking in profits.