If you’re interested in diversifying your investment portfolio or need more flexibility and spending power to make trades, you might want to consider margin trading. With this approach, you can use the funds a broker provides to buy an asset—to make larger trades or investments than your cash alone would allow. Here’s how it works and how to make sure you’re pursuing margin trading safely.
What is Margin Trading?
Margin trading occurs by borrowing money from a broker to be utilized to purchase an asset you might otherwise not have capital for to invest. This can allow for larger investment positions, all while using less of the investor’s own capital. These traders hope to see a significant return as they would if they made a standard purchase of an investment without investing as much of their initial capital into it.
While trading on margin can increase the potential for profits—as investors’ debts are minimized while the potential for returns is maximized—it can also increase the potential for losses. Understanding how to trade on margin and the risks involved should be recognized prior to trading on a margin trading platform.
Benefits of Margin Trading
The very aspect of margin trading that can increase your buying power can result in increasing your risk. A small movement that goes against your position can result in big losses. This is why it’s so important to manage your margin trading correctly.
The potential for increased reward comes with increased liability, especially when the market is moving against you. A large risk associated with margin trading is the margin call. If you lose money on your position, the broker may require the trading client to deposit money to keep holding the position. When the investor fails to satisfy the margin call, the broker will sell the investor’s assets to recoup the loan, typically at a significant loss.
Risk Management in Margin Trading
To mitigate risks, you should implement these strategies:
- Set Stop-Loss: These orders sell your position once it has reached a certain loss point and can help mitigate your potential loss.
- Do Not Over-Leverage: Do not borrow more money than you can afford to lose! By taking a more strategic approach to borrowing, you can avoid losing a ton of money when the market shifts against you.
- Be Aware of the Market: Make sure to monitor what is happening in the market as well as the potential catalyst that could make an investment work against you.
Getting Started with Margin Trading
If you decide that you do want to start using a margin account, take it slow. Make a few positions that are smaller in quantity to get a feel for how it works and become more confident in trading with more capital. Periodically monitor your positions and stay up to date with your brokerage in regards to borrowing terms to avoid any unnecessary surprises in your accounts.
Understanding how margin trading works in other markets such as futures trading further emboldens your trading strategy. Futures trading, using leverage to increase your position in the market as well as futures margins come with a host of risks you must mitigate to safeguard your trading capital and profit.
The Road Ahead: Margin Trading’s Future
The ever-evolving world of technology in trading makes margin trading more accessible to retail traders as many more providers are able to offer real-time quotes and advanced trading platforms, all complete with a plethora of risk management tools to utilize. To reiterate, both novices and experienced professional traders understand success in margin trading lies with the ability to manage both risk and reward.
Understanding the combination of advantages and risks enables prospective traders to trade on margin with confidence in order to diversify their trading portfolio and take logical advantage of the many opportunities in the market.
People also read this: 5 Must-Have Features in Quality Restaurant Chairs