Margin trading explained
What is margin trading?
Margin trading is a form of credit that can be used for trading. The extent of this borrowing is known as leverage. Leverage of 20:1 would mean that $20 can be traded for every $1 that’s in an account. This is a high-risk investment strategy that is becoming increasingly common in forex and cryptocurrencies.
This method can amplify profits when a trade goes successfully. Let’s imagine that, without a margin, you execute a $25 trade and make $10 on the transaction. When leverage of 20:1 is brought into the equation, meaning the trade is now worth $500, these profits would rise to $200. From here, the initial $500 is repaid – plus interest – leaving the trader with a tidy sum.
Although this proposition can sound tempting, there can be consequences if a trader makes a bad call. Under this same scenario, a loss of $10 would be multiplied many times over to $200. In the high-risk, emotion-filled world of trading, there is a risk that snap decisions can lead to excessive losses very quickly.
Margin trading meaning
To summarize, margin trading involves making investments with money you have borrowed – and some critics compare this strategy to gambling as the investor is liable for the full amount.
Should losses accrued through margin trading fall below a certain level, a broker may issue something known as a “margin call,” where a trader’s position will be liquidated unless they contribute additional funds.
To begin margin trading, investors normally have to go through an application process with the broker of their choice. As with other forms of borrowing, such as mortgages, credit checks are performed to ensure that the trader has the financial means to make repayments if necessary. Some countries also have regulations in place that limit the multiples that can be applied to margin trading.