Margin Trading – Margin is a common thing for traders. On the other hand, trading is an easily accessible business that anyone can enter. Your neighbors may make money trading, and you may not even know it. All you need is to understand the rules of the market and have some money for the first investment.
There it is difficult to reach higher levels to get big deals. Sometimes a novice trader can have an idea how to make a big profit from one trade but not have enough money. In this case, there is an option to lend money in a stock or exchange and put it in assets. This is called margin trading.
What are margins? Have you ever taken a bank loan? If so, then the principle of margin trading will be well understood by you. On the exchange, you can trade not only with your own funds, but also with borrowed funds. What is needed for this and how margin trading on the stock market is regulated, we will tell you below.
- 1 What is Margin Trading?
- 2 How Does Margin Trading Work?
- 3 What are the Advantages of Margin Trading?
- 4 Best Margin Trading Platform
- 5 Risks Involved in Margin Trading
- 6 What are the Maintenance Requirements and Margin Calls?
- 7 What happens if I can’t pay for margin calls?
- 8 Tips for Trading Margin
What is Margin Trading?
The meaning of margin itself has a simple mechanism. A trader takes a loan from another trader or broker and then uses it to make a deal. After the trade is closed, the trader returns the loan with interest. What remains after the trade is completed is the trader’s profit from the operation.
Let’s start right away with the main thing. As you may have guessed, margin is the conclusion of an exchange transaction using borrowed funds from a broker. This commodity relationship is also called “leveraged trading”. Please note, this takes place not at the expense of borrowed funds, but only with their use.
That is, in order to trade on margin, you must have a certain minimum amount of your own funds in your account, which will serve as collateral for the loan issued to the broker. We’ll talk in more detail about the mechanisms for providing and using margins below.
How Does Margin Trading Work?
This facility allows you to order more than your capital. Because the securities company where you open an account, lends the capital you need. Of course this is not the same as a bank loan. When trading on margin is made, you will be asked to select a percentage of the total order value. This investment is closely related to the concept of leverage.
In other words, your account will be used to process leveraged trades, thus representing the ratio of borrowed funds to margin. For example to make a trade of 100,000 using 10:1 leverage, you need to set up 10,0000 as capital.
Margin trading can be implemented for short and long positions. The open margin reflects that the shares that will become your assets act as collateral for the loan capital. This is important to understand, because the broker has the right to force the sale of the shares you own if the market moves in the opposite direction to the position you took.
In addition, when the loan you have made has matured, you are required to pay the margin debt according to the rules. Usually every broker applies loan interest on the margin they offer.
Even though it’s that simple, some trading platforms and markets usually have varying rules and leverage levels.
Usually, the relevant value applied in the stock market is a 2:1 ratio, but for CFDs it is often 15:1. Below is an example that can illustrate trading on margin.
- You have 1,000,000, you can buy 1000 shares which have a price of 1,000 per share
- If the share price increases to 2000/share, you will get a profit of 1 million
- if the share price drops to 500/share, you will lose 1 million
- You use that 1,000,000 to borrow another 1 million in order to buy 2000 shares
- If the share price increases to 2000/share, you will get a profit of 1 million
- If the share price becomes 500/share, you will lose 4 million
What are the Advantages of Margin Trading?
On the one hand, margin trading is an opportunity to engage in more significant transactions. It is not always easy to find money to enter the major leagues, so this way of trading is an opportunity to take out a loan without leaving the market.
But there are some disadvantages of this method. First and foremost, margin trading can be extreme in both the rewards and risks involved. Investors earn more. An investor can make transactions with borrowed money and get more profits than when trading with his own funds.
Investors make money by reducing prices. Investors can borrow money or securities. In the second case, he made a profit in a falling market. The broker provides leverage automatically after opening a broker account. Moreover, you do not need to sign and execute any documents.
Brokers provide leverage for free. If you use borrowed funds within one trading day, the broker does not take a commission for margin trading. Borrowing fees are only charged if the position is left open at the end of the trading day.
Best Margin Trading Platform
With commission-free trading, you might think all brokers are equal in fees. But keep in mind there are still other fees to consider and not all brokers will charge the same. The right recommendation for opening a margin account is the Mitrade broker.
Mitrade is a brokerage firm based in Melbourne, Australia founded in 2011 and overseen by Australian financial authorities. This broker specializes in trading, the financial technology industry and CFDs. The goal of this broker is to provide an accessible and user-friendly trading environment.
Mitrade offers its clients attractive trading conditions. Starting from excellent customer service to platforms that have been carefully designed. Another fact is that there is no minimum deposit requirement for all clients. Other reasons why many traders choose Mitrade are:
- Regulated and secure broker.
- There is a free demo account available with $50,000 in virtual money.
- There are tools that really help trading such as stop loss and take profit.
- Owns more than 100 popular assets: forex, gold, crypto, stocks, etc
- Available leverage up to 1:200
- No commission at all and low spread
Mitrade offers all its clients very tight spreads on all currencies. This is very interesting, because this company does not charge any commission on any trades In other words, you can trade stocks, indices, ET, Bitcoin, commodities and currency pairs with maximum leverage and lowest fees with Mitrade.
Start Margin Trading at Mitrade
As with other trading, to start trading on margin, you need to open an account first. Here are the steps to start margin trading with Mitrade.
- Visit Mitrade, and open an account.
- After that, verify electronically using your personal details provided in the application form. This verification complies with the ‘Know Your Client’ (KYC) regulations.
- Make a deposit to the account via your preferred method.
- Once the funds are in the account, select an asset to open a position and confirm your trade.
Risks Involved in Margin Trading
Margin trading does have very interesting benefits, but it is also full of potential risks especially if you don’t really understand it. The first thing you need to know, the broker does not provide leverage for all assets. The broker only offers leverage on liquid assets. The broker determines the leverage himself, so he may reduce the leverage on some assets or provide none at all.
Investors can lose. Leverage can bring not only good profits, but also significant losses. The higher the ratio of borrowed funds to equity, the more expensive each item changes in price. Leverage is useful in terms of a positive outlook, when investors correctly assume price movements. If the investor is wrong, he will suffer a loss.
Margin trading has a multiplier effect, and does increase investment returns. But it also works the other way around. The disadvantages of a failed transaction when using this method will be much greater.
You need to continue to keep the balance above the minimum value set by the broker. If your balance is below the minimum threshold, your broker will ask to increase the balance amount. Then, if your balance continues to be below the minimum threshold, then you will need to sell some or maybe all of your assets in order to maintain the total balance in your account.
Your broker has the right to take action against you if you fail to fulfill the margin settlement agreement. If you fail to comply, then your broker can liquidate your assets to recover the amount of margin you borrowed.
What are the Maintenance Requirements and Margin Calls?
Before you take advantage of margin, you and the broker must first sign an agreement. According to the rules set by FINRA, you need to have a balance above the minimum margin. The minimum margin is half of the initial margin, you cannot go below this amount. If the amount on the investor’s account drops to this mark, the broker will forcibly close the deal so that the investor does not lose his funds, and even more so the broker’s funds.
Once you meet the minimum margin, the maintenance margin will apply and require your account to have at least 25% of the total market value. Usually, brokers have different terms. Then, if the equity in your margin account falls below the maintenance margin limit, the broker will give a warning in the form of a Margin Call.
This means you have to deposit more money into your account or liquidate securities to meet maintenance margin demands. As explained above, your broker has the right to sell the securities in your margin account without the consent of both parties.
What is a margin call?
When you open an order, your broker will reserve a certain amount as a security deposit. In addition, the brokerage company, in this case the Forex broker, makes daily calculations of profitable and unprofitable floating transactions. This happens automatically. The same thing happens if what you predict does not come true and your Margin Call level moves down.
A margin call is a warning from the broker that the client’s funds are no longer sufficient to open new positions and provide current positions. Upon receipt of such notification, the investor must deposit additional funds into the account to restore the ability to secure transactions.
For example, a trader opens a short position for Euro/Pound, but suddenly the price goes up against the Pound. There is no need to immediately think that a trader will lose, because the market is a volatile thing, just like the weather. This explains that things can change, and soon the Euro could be cheaper than the GBP.
But what if the European currency is still experiencing a rapid increase in price? The free margin will melt, the percentage level will decrease, all this will continue until a Margin Call occurs and the order is closed automatically. That is why all traders’ deposits on the trading floor are conditionally divided into insurance deposits and free parts. The size of the leverage affects the number of free shares, as well as the number of lots. It is chosen by the trader when opening an account with the broker.
What happens if I can’t pay for margin calls?
It is clear that investing in the attractiveness of borrowed funds is in itself a rather risky business. Therefore, it is necessary to understand what happens if the development of events on the market is unsuccessful. If the price of a stock or other instrument purchased on a margin loan does not go in the direction the investor expects, or when the value of the other instruments of his portfolio falls, the account balance may drop too much.
Then the broker sends what is called a margin call to the client. If he believes that the market will change, then it’s okay to ignore this margin call. However, if this does not happen, and the asset continues to lose value, the broker will automatically close the position i.e., sell the stock, currency, etc. at current market prices. This will allow the broker to repay the loans made to investors.
How to calculate margin requirements?
Before you start trading, you need to have an idea of the margin requirements. This will make it easier to estimate how much you will earn or the possible loss. To calculate it, you can use the following formula:
Margin Requirements = (Position Size) / Leverage
Example: You want to buy AUD/USD with a position size of 3 lots (300,000) using 1:100 leverage and your account currency is AUD. So,
Margin Requirement = 300,000 / 100 = 3000 AUD
Through this formula, it can be concluded that the lower your leverage, the higher your margin requirements. That way, you need to provide more funds as collateral in opening positions.
Tips for Trading Margin
Margin borrowing when trading on the stock exchange helps increase your return on investment. At the same time, it doesn’t matter whether the market is falling or growing the investor gets the opportunity to carry out more operations and large-scale transactions than he can do just by attracting his own funds.
That way, you can earn more. There are risks to consider when using this tool. To avoid situations of margin calls and forced closing of positions, it is enough to follow a few simple rules:
- It is important to constantly monitor the market situation and control the adequacy of the account balance to close transactions and positions
- If the position is not profitable, it is better to get rid of it.
- If an unfavorable market situation develops, you may receive a message from the broker, then you should respond to it immediately.
In practice, it is not necessary to carry out complex calculations. All necessary indicators to control margin positions are reflected in the trading terminal. The main enemy in the market is their own soul, due to which novice investors make mistakes or make late decisions. You need to assess the situation wisely and not gamble.
All brokers have different margin rates, so learn all about the interest rates for margin accounts at any broker you are considering or wherever you already have an account. You should also pay attention to account minimums so as not to incur any fees or barriers to trading. If you’ve done your research and are able to take the risk, then margin trading might be for you.