Using funds borrowed from an investor or a broker to trade any asset that forms collateral for the taken loan. Simply put, it is trading by using a loan. The estimated gains, by the borrower, from trading are leveraged to access more funds for investors. When done well, it is possible to potentiate profits easily. With margin trading, a trader can trade in volumes that are higher than the amount a trader actually holds.
By way of example, if a trader predicts an individual asset's rise (e.g., Ethereum), they could use margin trading to increase their asset volume to change to go long – or go short should a price drop be predicted.
There are two parameters upon which margin trading profits depend: the range of motion and the movement of the product price.
Margin trading, unlike spot trading, needs a more in-depth understanding. Margin trading stakes are a lot higher. Although gains can be huge, so can losses if not much attention is paid to research.
In general, only the most experienced and advanced traders practice margin trading. It is possible to accumulate profits over a short time frame when invested well.
Since margin trading comes with a high risk, traders usually use a particular account called a margin account for their trading activities. This account means traders can participate in exchanging specific products that you can only trade over this type of account, for example, futures and short sales. Stocks and other such commodities can be traded with cash accounts as well as margin accounts. Margin trading is risky and therefore needs regulation control and rules that are enforced by governing and regulatory bodies to safeguard any trader from getting into difficulty.
Carrying out margin trading
Since digital assets’ exponential increase, the appearance of digital exchange platforms was inevitable.
Cryptocurrency and altcoin trading has increased in popularity in recent years and is more often becoming a vital income for a section of the global population.
Trading takes place in digital exchanges. This arose initially because of an increasing need to trade assets on secure platforms.
Margin Trading: how does it work?
Margin trading often looks like this:
- Available capital: $400
- Loaned amount: $800
- $1200 – eth at $20/eth – approx. 60 eth
- $60 sold at $25/eth to get $1500 ten days later
- Repayment of $800 loan (exclusive of interest)
- Repayment of $830 loan (inclusive of interest)
- Fees for the transaction: $20
- Profit: $250
There are different layouts on different platforms. This plan shows how SimpleFX works for margin trading.
- A user registers and logs into the SimpleFX WebTrader.
- The user selects margin trading and can then choose which assets they would like to trade.
- The user can input trading specifics. Traders can choose to go short or long. The order can be submitted.
- Once submitted, you can see all of the indicators of the trade.
These four steps are all you need to execute a margin order. They might differ slightly on other platforms but ultimately will be pretty equal.
The pros of Margin Trading
When executed with ultimate precision, margin trading offers high rewards. For investors, it opens up opportunities to trade beyond the exiting capital. Shares obtained via margin are often more than cash-acquired shares.
There is no constraint with margin trading as funds are available to withdraw. This can then generate higher profits.
Margin trading means that investors can trade when opportunities arise. There is a lot of volatility in the cryptocurrency market, so it can be challenging to understand the movements of the market.
It could be that opportunities come around with no notice. When this happens, margin traders can still invest. This means they can have an increase in profits.
Another added advantage is diversifying the investment portfolio. Investors can venture into productive assets and other opportunities that come up. Because there are extra funds, it is easier to diversify portfolios. Margin trading can also be useful when investors want to hedge downside risk. Short selling is on way of doing this. You can only short sell with margin accounts.
You can also potentiate gains using margin trading for ‘carry’ trades. A carry trade is when a low-interest loan is obtained by an investor and used to invest in assets with a high ROI.
From these advantages seen, margin trading can be very lucrative. Nevertheless, it is necessary to analyze all opportunities thoroughly.
Cons of Margin Trading
Just like margin trading can strengthen profits, it can also deepen losses; therefore, it is always necessary to research thoroughly and understand the risks before venturing into margin trading.
Here are some disadvantages:
- Potentiated loses – there are two investing amounts, which means there are risks of losing both quantities. Where the margin loan is given fell above 50%, the losses are likely more significant than 100%.
- Margin call – when there is a rapid drop in asset value, there might be a margin call. This is followed mostly by having to hand over a large amount of cash to cover any losses that result from the lowered price.
- Forced liquidation – collateral must be attached when taking loans. This is used to guarantee the money to recover. Assets can be sold to recover the investment if an investor doesn't honor a margin call.
- Interest and risks – these have a higher rate. If a loan is unpaid over a long time frame, there are fewer gains. Sometimes it’s best to break even. Margin account interest rates are not fixed and can fluctuate.
Investors have to analyze the advantages and disadvantages of margin trading before embarking on the practice. It requires a lot of discipline. Although the risks seem many, you can do things to combat them. For example:
- Prepare for losses – a responsible and ration investor will prepare for potential losses. Investors should invest in a point where they can cushion losses by other investments.
- Spreading the risks – you can prevent a total collapse of assets by using margin trading.
- Margin trading short term – investors can prevent long-term profit damage this way.
These measures will mean that an investor is fully prepared for any adverse conditions in the market and will mean that the investor isn’t entirely exposed financially speaking.
When done correctly, margin trading is advantageous. Nevertheless, like any trading practice, it comes with associated risks that can lead to huge losses.
Margin trading's effectiveness, therefore, is dependent on its investor. Responsible investors using margin trading with useful strategies on a good platform like SimpleFX WebTrader can achieve lucrative profits.