Trading on margin offers you the opportunity to amplify your profits but it poses a risk of magnifying your losses, too. Margin trading can form a crucial element of your strategy, so it's vital that you first have an in-depth understanding of what it is, how it works and the various pros and cons. This is our guide to trading on margin.
Margin trading enables you to gain exposure to a position while only committing a percentage of the capital that would be required to open that same position in a conventional trade. The remainder of the capital is lent to you by your broker but your profits and losses are calculated on the full value of the position, not just your initial deposit amount.
It's important to understand that trading on margin therefore has the potential to amplify your profits but the flip side of that is that, if the market moves against you, your losses will also be magnified. Throughout this guide we'll cover all the key points around margin trading, starting with how it works.
When you trade on margin, you do so by using leverage. The leverage on a trade will be displayed as a ratio - for example, 5:1. This is equivalent to a 20% margin and means that, for every $1 of capital that you put up, you are actually opening a position worth $5.
Your margin requirements will differ depending on your broker, the jurisdiction and the assets that you wish to trade.
The capital that you need to put up is known as your deposit margin. This is sometimes referred to as your initial margin or required margin. Then there is your maintenance margin, which is the amount that you need to have in your account to cover any losses that you may make on a trade. If your maintenance margin is not sufficient, it could result in a margin call, which we'll explain later in this guide.
Here's a theoretical example of how margin trading works:
It's important to remember, however, that margin trading can work against you to the same extent. If the value of Company XYZ had dropped to $90, then, you would be looking at a loss of $4,500.
Leverage and margin are closely related but they are not the same thing:
A margin call is a notification from your broker to let you know that you do not have enough funds in your account to cover the losses that you have incurred. You need to keep capital in your account as a maintenance margin but this can be exceeded if a market moves suddenly and significantly against you or if you fail to monitor your positions regularly enough to identify when you are at risk of receiving a margin call.
If you fail to act on a margin call, your broker will take steps to close down your position, because you have exhausted the amount of money that they are willing to lend you. The only way to keep open your position is to put up additional funds.
As they form such a crucial element of trading on margin, it's imperative for you to understand the steps that you can take to avoid being issued with a margin call. Here are a few suggestions:
The main instruments used in margin trading are contracts for difference (CFDs). CFDs are leveraged, derivative products which means that you do not take ownership of the underlying asset. Instead, you are speculating on the future performance of that asset.
CFDs are an agreement between a buyer and a seller to exchange the difference in an asset's price between the contract opening and closing. Find out more in our guide to CFDs.
A margin trade can offer a number of potential advantages. For example:
Any form of trading comes with risk attached. With a margin trade, you need to consider:
Your margin requirements are likely to differ depending on the markets you wish to trade. It may also vary based on your broker and, even then, the requirements can shift based on market conditions. The asset classes that you can trade on margin include:
Trading on margin may be more suited to some strategies than others. For example, if you wish to avoid the overnight fees that some brokers will charge, day trading might be more appropriate for your needs. The most common approaches include:
Find out more about margin trading with Tradu
You can open an account and start trading on margin with Tradu today. Our proprietary platform offers access to a range of underlying assets including forex, crypto, commodities and more. You can harness our outstanding suite of analytical tools to help to inform your decisions and shape your strategy. Gain exposure to larger positions for a fraction of the capital when you trade on margin with Tradu.
With Tradu you can trade crypto via CFDs.