What Is Margin Trading? How To Trade On Margin

Using margin trading offers you the opportunity to amplify your profits but it poses a risk of magnifying your losses, too. Trading with margin 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.

What is margin trading?

Margin trading allows 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 provided as collateral for the margin loan by your broker, where margin is the collateral you provide; however, your profits and losses are calculated on the full value of your trade, not just your initial deposit amount. To engage in this practice, you’ll need to open a margin trading account with your broker, which allows you to access the funds required for leveraged positions.

It's important to understand margin trading has the potential to amplify your profits, but margin can magnify your losses equally - margin trading can magnify both gains and losses calculated on the full value of your trade, making trading a double-edged sword when market moves in the opposite direction. Throughout this guide we'll cover all the key points around margin trading, starting with how it works.

How does trading on margin work?

When you trade on margin, you do so by leveraged trading. 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 type of margin will differ depending on your broker, the jurisdiction and the assets that you wish to trade.

As a trader, to properly understand margin requirements, you must recognize that margin means the deposit needed to control a larger position. Margin trading requires careful consideration of the margin required for each trade, as margin when trading different assets varies significantly based on margin obligations.

The capital that you need to calculate margin for is known as the minimum margin requirement.

This is sometimes referred to as your initial margin requirement.

Then there is what's called the maintenance margin requirement, which is the amount of money in your account you need to maintain sufficient margin 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.

An example of a margin trade

Here's a theoretical example of how margin trading works:

• Company XYZ has a buy price of $100 per stock.
• You think the value of Company XYZ is set to rise, so you choose to open a long position
• For this type of trade, your broker sets a margin rate of 20%
• That means that, for every share you want to buy, you meet the minimum margin requirement of $20, rather than the full $100.
• You choose to buy 50 shares, which means putting up $1,000 to open a position worth $5,000
• The value of Company XYZ does rise as you predicted, to a sell price of $110, at which point you opt to close your position
• Your position is now worth $5,500 from an initial outlay of $1,000 - a profit of $4,500 before any commissions or charges are deducted. This demonstrates how margin investing works - your profits are calculated on the full value of the trade ($5,000), not just your additional margin deposit.

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, you would face losses if the market moves against you - a loss of $4,500 calculated on the full value of your trade.

What's the difference between margin and leverage?

Leverage and margin are closely related but they are not the same thing:

• Margin refers to the amount of capital that you are required to put up to open a position. It is usually displayed as a percentage.
• Leverage is used to illustrate how many times your margin will be multiplied to calculate the full value of your position. It is usually displayed as a ratio.

What is a margin call?

A margin call is a notification from your broker when you don't have enough cash in the account to meet the margin requirements for your positions.

You need to keep capital in your margin 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 in your trading account, because you have exhausted the amount of money that they are willing to lend you. When you fail to meet the margin call, you must provide additional margin to bring the account back to acceptable levels or your position will be closed.

How can you guard against a margin call?

As they form such a crucial element of margin in trading, it's imperative for you to understand the steps that you can take to avoid being issued with a margin call.

Understanding margin obligations is crucial. Here are a few suggestions:

• Ensure you have a sufficient maintenance margin to cover your positions.
• Regularly monitor all your positions so that you can quickly be alerted to any losses.
• Be aware of which assets are the most volatile and therefore more susceptible to sudden movements that could go against you.
• Don't open too many positions or trade too many markets at once, in case multiple trades start to incur losses all at the same time.
• Be realistic in the size of the positions that you can open, in relation to the amount of capital available to you.
• Use a stop loss, which will automatically close a position if and when it reaches a certain value.

Which instruments are suited to margin trading?

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.

What are the benefits of trading on margin?

Trading assets on margin can offer a number of potential advantages. For example:

• It increases your market exposure for a fraction of the capital that you would need for a conventional trade.
• Smaller deposits can free up additional capital to take up other positions and diversify your portfolio.
• CFDs allow you to trade in either direction so it's possible to make profits from either bullish or bearish markets, as long as your prediction proves correct.
• It provides an opportunity to learn how to trade with enhanced market exposure, allowing traders to get a margin account for online trading while controlling the full value of your trade with less capital.

What are the risks of trading on margin?

Any form of trading comes with risks of margin. With a margin trade, you need to consider:

• Your losses could be magnified if the market moves against you. They will be calculated on the full value of your trade, not just your deposit amount, so you could stand to lose a lot more than your initial outlay.
• Trading on margin essentially involves borrowing money from your broker so, if you maintain a position overnight, you are likely to incur margin interest.
• If you fail to keep a sufficient account balance, your positions could be closed down by your broker before they have a chance to recover.

Which markets can you trade on margin?

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. Different markets require varying amounts of margin required. Whether you're trading stocks, forex, or other securities, understanding the concept of margin for each asset class is essential for successful margin investing. A trader must be aware that currently trading different assets involves different margin obligations. The asset classes that you can trade on margin include:

• Forex trading
• Shares
• Indices
• Commodities

Which strategies can you adopt for margin trading?

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:

• Day trading: Opening and closing positions within the same session or the same day. Find out more in our guide to day trading.
• Trend trading: Using analysis of past performance in an attempt to identify potential future patterns. Find out more in our guide to trend trading.
• Swing trading: Identifying where an asset's value might start to buck an established trend and move in the opposite direction. Find out more in our guide to swing trading.
• Range trading: Recognising the typical upper and lower limits of an asset's value before opening positions within that range. Find out more in our guide to range trading.
• Breakout trading: Spotting opportunities where an asset's value could defy its usual range and exceed its upper or lower limit.

Find out more about margin trading with Tradu

As a trader, you can open an account and start trading on margin with Tradu today. Our trading platform offers access to a range of underlying assets including forex, commodities and more.

You can learn how to trade on margin with our platform, helping you understand margin obligations while currently trading with real capital and proper risk management. Gain exposure to larger positions for a fraction of the capital when you trade on margin with Tradu.

Leverage trading guide