Basics

Don't Trade on Margin Unless You Understand What It Means


Margin trading is a form of leveraged trading that takes place from a margin brokerage account. With a margin account, the cash you deposit has greater nominal buying power, as the brokerage will loan you the difference automatically or require that you post a smaller amount of collateral when placing a trade.

Let’s see more about how to trade using margin and why you need to understand what it means.

To operate a margin account in forex trading for example, you need to have a specific knowledge of what the margin percentage will be. Forex Brokers may require a minimum deposit of money or assets to be used as collateral when placing a trade from a margin account.

For example, if you have a balance of $10,000 and want to use it all to buy a forex pair that you’re expecting to increase by 2%, on a normal account, you can use the $10,000 as 100% margin and target a profit $200.

However, from a margin account with a 50% margin requirement, you can buy the same quantity of currency that you did before with only $5,000 from your $10,000 balance. This is because the broker is putting up the other $5,000 behind the scenes.

In either example, if you are right, you’ll win the same $200, but in the case of margin trading, it represents a 4% profit, because the $5,000 was leveraged.  At the same time, a 2% loss on that same trade would have caused a 4% loss on a leveraged position at 50% margin. Therefore, margin trading can be highly risky, as profits and losses can be amplified due to leverage.

Lastly, any leverage obtained from a margin account is not free, as it has interest to be paid to the broker when any positions are maintained for more than one day (usually past a specific time each day), generating rollover costs.

All the features of margin accounts are designed to be useful for short-periods and trading with a high level of certainty. Most stock brokers don’t allow margin operations with high-risk assets, like Over the Counter (OTC) products or penny stocks. However, with commodity and derivative trading, as well as forex trading, it is almost always done from a margin account.

That’s why it is important to know what your margin requirement is, and any levels that can trigger a margin call, also known as a liquidation call (i.e. when trades are closed automatically due to insufficient available balance).  In some cases, a margin account can also cause a negative balance.

Generally, a low margin requirement will mean higher leverage, while a higher margin requirement will mean lower leverage. Here are examples of various margin requirements and their associated leverage amounts:

  • 100% margin = zero leverage
  • 50% margin = 2:1 leverage
  • 25% margin = 4:1 leverage
  • 20% margin = 5:1 leverage
  • 10% margin = 10:1 leverage
  • 5% margin = 20:1 leverage
  • 1% margin = 100:1 leverage

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Takeaways

  • Trading on margin can be a useful tool to increase your buying power and profit potential, but it also substantially increases the risk of loss.
  • Margin trading suits better to short-term operations, when the information about market movement is clear.

Good trades can often have larger margins requirements to operate; our Artificial Intelligence-powered strategies can help you to identify the best forex trading opportunities.

Disclaimer: Forex and Contracts for Difference (CFDs) are complex instruments and come with a high risk of losing money due to leverage. Forex trading is not suitable for everyone. You should consider whether you understand how forex and CFDs work and whether you can afford to take the high risk of losing your money.

The forex brokerages displayed shall disclaim the overall performance of traders in their platforms. Oanda warns that 76.8% of retail forex traders lose money trading CFDs. XTB warns that 80% of retail forex traders lose money trading CFDs. The forex broker Fxcm warns that 69.66% of retail forex traders lose money trading CFDs.

The performances aforementioned are not related to Wiseinvest AI forex trading and AI forex signals system. You can check the performance of our AI forex system on our dashboard.