HFM information and reviews
HFM
96%
FXCC information and reviews
FXCC
92%
FxPro information and reviews
FxPro
89%
FBS information and reviews
FBS
88%
XM information and reviews
XM
86%
Exness information and reviews
Exness
86%

What Is Margin Trading And How Does It Work?


Investors trading in the financial market commonly face issues with equity, which creates difficulties in conducting operations with currency pairs and other assets. This lack of equity is primarily due to the modest income generated from investments. Consequently, investors explore various options to address this issue, with the most popular being a margin provided by brokerage companies as collateral while obtaining credit. However, the margin has its unique features and drawbacks that a trader must be aware of before making a decision.

What Is Margin In Forex Trading?

Margin is a fairly common term, which is often encountered by participants of stock and currency exchanges, in particular forex. Different economic spheres, it has ambiguous interpretations, so it is recommended not to confuse margin in the foreign exchange market with concepts of other areas. Forex margin is a collateral amount that a trader must deposit with a brokerage company to obtain a loan with a specific maturity.

The money provided under specific conditions can only be used when trading on the international currency market. It is also worth noting that the loan amount may be higher than the client's deposit. Margin most often takes the form of cash or securities transferred to a dealing center or intermediary. They are the insurance security for the creditor and the guarantee of return of the debt.

With the help of margin, the trader gets attractive opportunities for making profitable trades in large volumes.

Different Ways Of Using Margin In Trading

Margin trading can be used to place two types of positions:

Long

It is used when a trader plans to earn on the growth of the acquired asset price. The basic idea of margin trading in long positions is very simple: first, it is necessary to buy cheap, and then sell expensive. Before approving a trade, the brokerage company will automatically calculate the size of the investor's liquid portfolio and determine both types of margin. If the size of the portfolio is greater than the initial margin, the broker will calculate the maximum amount of the order. Otherwise, it will not be possible to open a position.

To calculate the maximum possible order volume, the difference between the portfolio and the initial margin is divided by the risk rate. After that, the position is opened, the trader is debited from the account, and the purchased asset is added.

Then the amount of liquid portfolio is recalculated again and compared to the minimum and initial margin. If the size of the portfolio turns out to be higher than the initial margin, the investor can place the next order. And if the amount of the portfolio becomes below the minimum margin, a Margin Call is sent to the trader.

Short

It allows one to receive income in case the value of an asset decreases. According to exchange rules, an investor cannot sell assets they do not own. Therefore, the trader has to borrow assets from the broker to make money on the price decline. Later, the assets have to be redeemed and returned to the brokerage company. Trading short is riskier than trading long. This is because assets can rise in value indefinitely. Over time, its value can increase by 100%, 200%, 1000%, or even more. But there is no asset whose price will fall below 0. Therefore, the fall in value is limited to 100%.

Because of this, a trader who opens short positions finds themself in a more risky position than a person who invests money counting on asset growth. That is why the short risk rate on an asset is always set higher than the long risk rate.

A trader should be especially careful when placing short positions.

Margin Trading: Examples

It's easier to understand the nuances of margin trading using examples with specific numbers.

Trading Long

A trader sees that the exchange rate of the British pound to the American dollar is 1.36. The investor thinks the base currency will get stronger relative to the quoted currency and decides to make a deal with 1:100 leverage. To do this, the trader buys 100×100=10000 pounds for their $136. The British currency has indeed risen, and the new exchange rate of the currency pair is 1.38. Then the investor sells the pounds they have. From each pound sold, they earn $1.38-1.36=0.02. But since the trader had a total of 10,000 GDB, the total earnings are $0.02×10000=$200 (net of spread and transaction fees).

If borrowed funds were not used, then British pounds would have been bought 100 times less. And then the earnings of the investor would be only 2 U.S. dollars instead of 200.

Trading Short

The investor believes that the particular stock is overheated and will soon become significantly cheaper. But they do not have these shares in their portfolio and, therefore, cannot sell them now at a high price. Consequently, the trader decides to sell short. To do so, they borrow 40 shares from the broker at $260 each. In fact, the total amount of the trade is $260×40=$10400.

By the end of the day, the value of the share actually falls to $220. To buy back 40 shares, the trader spends $220×40=$8800. They return the shares to the broker and earn $10400-$8800=$1600 (less the brokerage commission, spread, and asset fees).

Margin Call And Stop Out

Margin Call and Stop Out are completely different operations, usually working in tandem. And their purpose is the same - to prevent the complete bankruptcy of the trader. The Margin Call operation is a warning to a market participant that their deposit is not enough for the maintenance of this position, and they must urgently decide - to deposit if a trader is a risky person and wants to wait for the turn of events to get a profit or to close all or most unprofitable trades. It is considered that the Margin Call is a telephone message (which has not been practiced for a long time) or a message by other means of communication between traders and brokers about the lack of money in trading accounts. As a rule, such Margin Call operation has not been practiced for a long time. In its turn Stop Out is a certain level of losses at which the (most) unprofitable trades are automatically closed.

In this case, a broker independently, without warning, closes the positions. Practically it is the same Stop Loss, but its value is usually defined by a broker. Stop Out is expressed in percent and is defined as the ratio of the trader's assets (Equity) and pledge (Margin). As a rule, the minimum value of Stop Out at which the trades are forcibly closed is 20 percent.

And there is no contradiction in this. For example, you open a position with $200 on the deposit. Immediately $100 is smoothly transferred to the pledge. The amount of free funds is also equal to $100, the level is 200%. The market has changed direction, the trade went against you. At the achievement of a loss of -$100, you run out of free funds, but the trade will not be closed. The point is that the Stop Out order is still 100%, since ((200 - 100) / 100) x 100% = 100%. The loss increases and reaches a value of -$180. In this case, Stop Out = ((200 - 180) / 100) x 100% = 20%. At this level of loss, the order is terminated automatically, as a Stop Out is triggered. Thus, only $20 will remain in your account, although the deposit was returned in full. On the one hand, Margin Call and Stop Out orders help the trader to avoid bankruptcy, i.e. their accounting may seem positive. But on the other hand, the presence of such operations can provoke unjustified risk when expecting the market to turn in the other direction. There is a probability of inability to open a position even with a minimum lot, if Stop Out starts to trigger several unprofitable positions, and in this case, the margin level will increase.

Pros And Cons Of Margin Trading

Margin trading has a lot of advantages, including:

But for all its advantages, margin trading is still a pretty risky business. After all, when using leverage investors risk increasing the number of possible losses in case of placing a losing trade. Moreover, the bigger the leverage, the stronger can "sink" the deposit or even plummet to zero.

Other disadvantages of margin trading are as follows:

Conclusion

Margin trading is a useful tool, with the help of which an investor attracts substantial borrowed funds to be able to earn additional profits. However, trading with high leverage carries high risks, so it should be used by experienced traders. Novice traders, who are not yet able to manage capital and correctly predict the movement of prices, should use margin trading with low leverage. In this case, one has an opportunity to increase net profit, and the risk of losing the invested capital is minimized.

#source


RELATED

Mastering Risk Management Across Market Phases

Navigating the ever-changing waters of financial markets can be an exhilarating journey. Markets, like tides, ebb and flow, shifting from bullish to bearish, and prices rise and fall...

Portfolio Diversification: What Benefits Can a Forex Trader Get by Using it?

Collect as many eggs as you can, and don't put them all in one basket - a fundamental principle of a wise trader. Trading is a big road where you can face sharp turns and bumps...

Three Ways to invest Your Red Packet Money in Times of a Worrying Economy

With Lunar New Year around the corner, preparations have been in full swing to welcome the Year of the Rabbit on 22 January. Friends and families will gather for feasting...

Exploring The Advantages Of Trading Minor Forex Pairs

In the vast and dynamic world of forex trading, minor currency pairs often hold untapped potential for traders. While major currency pairs dominate the forex market...

How to Avoid Overtrading

In Forex, when traders start excessively buying and selling currency while disregarding their strategy, they are "overtrading". Overtrading is dangerous as it often happens when traders get caught up...

Navigating the Commodities Market: A Comprehensive Insight into Recent Trends

In the intricate web of global markets where economic fluctuations resonate across borders, the art and science of trading commodities have unfolded into multidimensional realms...

Innovations in Forex Trading Technology

Read this article to learn about advancements in trading technology, such as AI-driven trading bots and advanced charting tools.

Unlocking Infinite Possibilities: A Deep Dive Into the Compelling Reasons for Pursuing a Career in Day Trading

In the continuously evolving and dynamic domain of finance, day trading emerges as a prominent pathway for those endeavoring to master the fast-paced ebb and flow of the stock market...

When can you trade forex?

The forex market is the world’s largest financial market. It operates around the clock, 5 days a week, providing abundant trading opportunities to traders globally...

The Importance of Fundamental Analysis in Forex Trading

In this article, we discuss the importance of fundamental analysis in forex trading and provide an overview of some key economic indicators.

Seven Key Components of a smart trading plan

Trading decisions typically depend on several factors. These include market volatility, economic or geopolitical events or announcements, market sentiment, investment goals, etc...

Why traders shouldn’t underestimate an Economic Calendar

Brace yourselves for the ultimate weapon in your trading arsenal - an Economic Calendar, revealing the future of financial markets. So, why should you care?

Six Habits of Successful Investors

You won’t make a fortune at the snap of your fingers unless you’ve won the lottery or received an inheritance. Wealth should be the result of a systematic approach...

Forex Affiliate Programs: Your Guide to Optimal Earnings

Forex trading is often celebrated as a method to generate substantial profits. However, there exists another, less conventional avenue for monetizing the markets: forex affiliate programs...

Mastering the Art of Hedging: A Comprehensive Guide

Hedging, a risk management method embraced by investors in financial markets, serves as a shield against potential inflation risks. It involves acquiring assets, such as shares, that are likely to appreciate during periods of rising price levels...

Who has lost the most money ever on the stock market?

Who has lost the most money on the stock market? Continue reading today's article to learn more! In the world of markets and trading just as profits take place on a daily basis, losses are also recorded on a daily basis...

Beginner’s Guide to Forex Rollover Rates

In the forex trading industry, traders exchange one currency for another, with the exchange rate determined by the supply and demand for the traded currencies...

Precious metals trading made clear: an Octa guide

With its unwavering commitment to clarity, the international broker Octa unravels another facet of trading. Grasp the essentials of precious metals trading in an uncomplicated, transparent manner...

What Is Money Flow Index (MFI) In Forex Market Trading

One of the most important functions of financial markets, including the foreign exchange market, is the redistribution of money. Through the purchase/sale of stocks....

Unlocking the Potential of Real World Assets (RWAs) in Crypto

The world of finance is witnessing a transformative revolution with the advent of real world asset tokenization, or RWAs, in the cryptocurrency space. Imagine having the opportunity to own a fraction...

Vantage information and reviews
Vantage
85%
FP Markets information and reviews
FP Markets
81%
IronFX information and reviews
IronFX
77%
T4Trade information and reviews
T4Trade
76%
Just2Trade information and reviews
Just2Trade
76%
FXNovus information and reviews
FXNovus
75%

© 2006-2025 Forex-Ratings.com

The usage of this website constitutes acceptance of the following legal information.
Any contracts of financial instruments offered to conclude bear high risks and may result in the full loss of the deposited funds. Prior to making transactions one should get acquainted with the risks to which they relate. All the information featured on the website (reviews, brokers' news, comments, analysis, quotes, forecasts or other information materials provided by Forex Ratings, as well as information provided by the partners), including graphical information about the forex companies, brokers and dealing desks, is intended solely for informational purposes, is not a means of advertising them, and doesn't imply direct instructions for investing. Forex Ratings shall not be liable for any loss, including unlimited loss of funds, which may arise directly or indirectly from the usage of this information. The editorial staff of the website does not bear any responsibility whatsoever for the content of the comments or reviews made by the site users about the forex companies. The entire responsibility for the contents rests with the commentators. Reprint of the materials is available only with the permission of the editorial staff.
We use cookies to improve your experience and to make your stay with us more comfortable. By using Forex-Ratings.com website you agree to the cookies policy.