Margin Trading | The pros and cons of trading on margin
It is considered Margin trading One of the most profitable areas of trading, but at the same time it involves higher risks than other areas, so how can the investor achieve balance and make a profit without falling into losses? This is what we offer you today in this report.
What is margin trading?
Simply put, margin trading is about borrowing from the brokerage firm, to raise capital so that you can trade more than you can with your own money.
From this definition, the first challenge for investors is in the margin, as they must achieve higher returns than the loan they took.
In order for them to start making profits, and here we see that margin trading allows you to make a free profit without entering with your own capital. But at the same time, if you suffer a loss, you will be in direct confrontation with the brokerage firm because of the outstanding loan.
That is why we have found that most of those who tend to trade on margin are giant investment institutions with experience in this field. Such as mutual fund managers and hedge funds, to identify safe or less risky investments with sufficient liquidity to handle potential losses.
Also read: Contract trading in Forex and what is CFD trading
What is leveraged trading?
Leveraged trading can help investors increase returns from even small price changes, greatly increase their capital, and increase their exposure to the markets.
But it should be noted that leverage can work for or against you. While you can make big profits when asset prices are going your way. You also incur big losses when prices move against you.
When you trade with leverage, you are cutting a “small amount” but have the opportunity to control a much larger trading position in the market.
The small amount is what is known as the “margin”. The amount of leverage offered by the broker depends on the regulatory requirements that it adheres to, in all jurisdictions where it is allowed to provide trading services.
With leveraged trading, the trader only needs to invest a certain percentage of the total position. This can change depending on the amount of leverage offered by the broker. and the amount of leverage a trader would like to apply.
In addition, traders use leverage based on their level of experience and investment goals.
In addition to the primary market in which they trade. In most cases, professional traders tend to use leverage more aggressively. While newer and less experienced traders are generally advised to use leverage with caution.
Also, conservative traders tend to use leverage, while traders with a high appetite for risk can use leverage flexibly.
The type of market you trade in can also determine the amount of leverage that traders can use.
For example, gold and bitcoin must be traded with minimum leverage. While less volatile assets that do not experience significant price fluctuations can be traded. Like the EURCHF, with higher leverage levels.
The basics of trading on margin
As explained above, “margin” is the amount of money a broker allows a trader to extract in order to trade a much larger position in the market.
It is basically a security deposit held by the broker, when trading positions are held. The price changes in the market will also change the margin conditions. On most platforms information will be displayed about the variable margin terms in your trading account, here is what the different definitions of margin and other terms mean:
It is the trading capital in your account, i.e. the amount you deposited.
This is what we discussed earlier as your broker requires you to include it as a “security deposit” to hold a position in the market.
It is often expressed as a percentage. For example, if you use a leverage level of 100:1, your margin requirement is 1%. If you are using 400:1 leverage, your margin requirement is 0.25%.
This is the amount of money the broker has as a “safety” so that you can keep track of your open trading positions. The money is still theoretically yours, but you can access it only after you close open positions.
This is the money in your trading account that is available to open new trading positions in the market.
A margin call is a notification from your broker that your margin level has fallen below the required level.
This is a wake-up call for traders. A margin call occurs when losses on an open trading position exceed (or are about to exceed) the used margin.
When you get a margin call, you basically have to add more money to your trading account to keep the positions open.
Otherwise, the broker will close the open position automatically, for example, a margin call level of 20% means that your broker will send a margin call notification when your open positions incur losses of more than 80% of your account balance.
Also read: How to profit from trading and the best trading strategies
Advantages of leverage
Trading on margin has many advantages, which we explain to you in the following points:
- Capital increase: Leverage improves the capital available to invest in different markets. For example, with a leverage of 100:1, you can effectively control $100,000 in just $1,000 worth of trading capital. This means that you can allocate large sums of money to the different trading positions in your portfolio.
- Interest free loan: Leverage is basically a loan provided by your broker to allow you to get a larger position in the market. However, this “loan” does not carry any obligation in the form of interest or commission and you can use it however you like when trading.
- Maximum benefits: Leveraged trading allows traders to make huge profits from trades that go in their favour, the profit is taken from the controlled trade position and not from the margin limit. This also means that traders can make significant profits even if the underlying asset makes marginal price movements.
Advantages of trading on margin
- Mitigating Low Volatility: Price changes in the markets usually occur in cycles of high and low volatility. Most traders like to trade in highly volatile markets because money is made up of price movements. This means that periods of low volatility can be particularly frustrating for traders due to the lack of price action that occurs. Fortunately, with leveraged trading, traders can make higher profits even during these seemingly “boring” times of low volatility.
- Trade in featured markets: Leverage allows traders to trade instruments that are considered more expensive or prestigious. Some instruments are priced at premiums and this can turn away many retail investors. But with leverage, such markets or assets can be traded, exposing the average retail investor to the many trading opportunities that it presents.
Disadvantages of leverage
- Inflated losses: The biggest risk in trading with leverage is that, just like gains. Losses are also magnified when the market goes against you. Leverage may require a minimum capital outlay, but since trading results depend on the total position size you control, losses can be significant.
- Margin Call Risks: The dreaded “margin call” from your broker occurs when floating losses exceed trading on used margin. Since leverage magnifies losses, there will always be a risk of a “margin call” when you have open trading positions in the fast-moving financial markets.
Margin call and margin level
In trading on margin in the event that the trader does not want to close the deal at a loss. In this case, the loss will not be realized and the trader can track his profits and losses instantly based on the current market prices across it.
It shows unrealized gains and losses (floating gains and losses) for each trade as well as the total of all unrealized gains and losses.
You can also follow the change in the market balance based on the real-time evaluation of transactions at the current market prices.
Which is usually the most important thing for a trader to follow, as the market balance must not fall below a certain level, to keep offers open.
A lower level of market equity is specified, which is called the margin call level.
As the market equity drops below the margin call level, the trader must deposit additional funds to improve his market equity or close out some positions to free up more margin for use on open trades.
Or if you do not perform any of the above steps, the system will close the positions at the currently available market prices.
Margin call level is the level of market equity as a percentage of the margin required for open positions in an account.
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Margin trading risk management
Trading on margin is a double-edged sword, as the trader can maximize his profit by trading multiples of the invested capital, but at the same time increase the risk.
The loss can also be significant when trading large sums.
Here the trader must follow an appropriate risk management mechanism to control these risks while continuing to benefit from the financial leverage provided by the margin trading system.
The trader can also manage the risks by placing stop-loss orders so as not to incur large losses in the event of sudden market movements.
Where the trader can place stop-loss orders at levels prior to the margin call stage. Thus, it can reduce the open positions in the account in the event of rapid market movements and avoid mandatory closing of all trades.
You can also use an entry stop order to hedge a price drop without having to close the position. Where you can then close the hedge position when the risk is gone, or make an additional deposit and continue with your position.
Margin trading It is one of the complex tools that must be adhered to in order not to lose all your money, as we mentioned in the article, and therefore you must be careful and manage your financial position professionally.
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