Margin trading is a mode, when an investor trades with borrowed money or borrows securities at the broker. For a loan, you need a collateral - assets in a brokerage account, including currencies. It is called margin. therefore, in order to get a loan, an investor must have money or securities. The ratio of own and borrowed funds is called leverage. There are two types of margin trading: in the long (long position) and short (short position).
Benefits of margin trading
- For an investor, margin trading opens up the opportunity to trade for a large amount, than he has at his disposal, which means that the size of the possible profit also increases.
- With margin trading, investors can easily seize trading opportunities as they arise.
- With margin trading, investment portfolios are more diversified, which is associated with the use of additional funds.
Disadvantages of margin trading
Margin trading can be a tool for generating additional profits, but it also implies a significant increase in risks. The main disadvantages are:
- Potential losses. Margin trading involves an increase in the principal amount of the investor, but, when it comes to losses, damage increases exponentially.
- Forced sale. In margin trading, assets are used as collateral and can be sold to recover borrowed funds in the event of, if the investor does not fulfill the requirements of the creditor.
- Margin trading is a loan, rate at which is charged for each day of use of borrowed funds. The longer the loan remains unpaid, the more the broker will have to pay.
Investors need to carefully analyze the pros and cons of margin trading, before making such transactions. Margin trading requires discipline and careful analysis of the market situation, as careless use of leveraged assets and unfavorable development of the market situation can lead to partial or complete loss of invested funds.