Margin trading is the process of trading assets with the use of borrowed funds provided to a trader by a brokerage company for a certain amount of money (margin). Margin trading or trading with leverage allows to trade in the Forex market without having a large amount of capital.
Leverage
Depending on the market you trade in (stock or currency), brokerage companies may offer leverage from 1:1 to 1:1000, i.e., a trader gets a loan of the same amount he owns or a sum 1000 times exceeding his own capital. In the Forex market, the size of leverage is usually from 1:100 to 1:500. The provision of a loan by a dealing company allows to perform speculative operations in the market with large amounts of money. Meanwhile, if a trader makes a large profit using the credit which exceeds his own funds by several times, the profit will belong only to him, and in case of unsuccessful transactions, the loss may not exceed the size of his own funds, that is to say a trader will not be in debt to a brokerage company.
Learn more about What is Leverage in Forex
Margin lending conditions
- Funds or other assets, which were deposited on the account of a brokerage company, serve as a pledge for margin trading;
- During the trading session, the credit is provided for free. A special fee (swap) is charged for transferring the position to the next day.
The size of margin
The size of margin depends on the market segment, the liquidity of traded instruments and the brokerage company. In currency market, the margin does not usually exceed 2%, while in the stock market it may reach 50%.
If the loss of your open positions draws near the margin size, the broker will offer to deposit the necessary sum of money (the requirement to provide additional funds is called Margin Call or “risk warning”), otherwise the positions will be forcibly closed (Stop out).
Positive and negative sides of margin trading
An absolute advantage of margin trading is the opportunity to make a large profit with a small initial capital on a trading account.
The negative side of margin trading is the great risk - the bigger the leverage, the higher the risk of losing funds in case the market moves “against you”.
No matter how attractive high leverage may seem, do not use the maximum possible leverage. It should be also noted that in case of transferring a position to the next day, you will have to pay swap for the whole volume of the position, that is why it is better to close all the positions by the end of the day.
