Many investors will grab any opportunity to increase their profits since it is worth the risk. Some consider taking less risky means to increase their portfolio consistently, whereas some do not mind taking bigger risks. There are many investment opportunities for big risk-takers which involve the addition of leverage, with margin trading being the most famously used means. If you have a small amount in your portfolio but intend to make huge returns by correctly predicting securities with future prospects, then you may want to consider trading on margin.
Margin trading is a faster means of making huge money for old investors that know how to analyze the market correctly. However, due to the high risk involved in margin trading, traders, especially newbies, are encouraged to be cautious when trading on margin. This guide will provide you with the basic information on margin trading and if it is worth investing in.
Meaning of Margin Trading
It is called margin trading when you borrow money from a brokerage company and then use it to buy stocks. In simpler terms, it is similar to getting a loan and using it to buy stocks to repay the loan later with interest. Investors increase their returns by trading on margin, especially if the amount in their investment account is not much. Although margin trading has huge returns potential, the risk involved is high. The same way profit increases with margin trading are the same way loss increases peradventure market goes against the investor.
Also, before any investor can trade on margin, there are certain requirements set by the brokerage company that needs fulfilling. One of the requirements is for the least acceptable amount to be present in the investor’s account, which is known as the minimum margin requirement. The minimum margin requirements vary from one brokerage company to another. Borrowing from a brokerage company is impossible without meeting the minimum margin requirements.
How It Works
Before discussing whether to invest in margin trading, it is important to understand how it works. Assuming you want to buy a stock trading at $10 per share using $2000, you only have $1000in your investment portfolio. Borrowing $1000 from the brokerage company to add to the initial $1000 of your own and purchase 200 shares is possible. Instead of trading with $1000, with the margin trading, it is $2000 that will be appearing.
Assuming a 20% increase in the stock price by moving from $10 to $12. The worth of the initial 200 shares, $2000, becomes $2400. Thus, the amount reflected in your account becomes $1,400. However, assuming there was a 20% decrease in the stock price from $10 to $8. The worth of the 200 shares becomes $1,600, and the amount reflected in the account after margin trading is $600.
Should You Invest In It?
Investors, especially newbies, do ask if they should invest in margin trading or not. Although traders tend to increase their returns hugely by trading on margin, they tend to lose a lot if it were to go sideways. Two things are important when trading margin and they include:
- Knowing the risks it entails
- Understanding the broker’s demand
The impossibility of accurately predicting short-term movements and a huge event that will affect the market makes margin trading very risky. Lack of control over the timing of a margin call makes margin trading very dangerous because there is a chance that you may need to liquidate your asset. Also, you need to meet certain requirements to be eligible for the brokers to borrow your money which is an extra cost you can lose in margin trading. Traders, especially newbies, are encouraged to steer clear of investing in margin trading due to the lack of clarity on the amount they have in equity and the borrowed ones. However, brokers benefit from a trader trading margin since whether you lose or win, you will return the borrowed money even with interest.
The forex industry provided many means for investors to increase their returns, with each of the means having its risks and rewards. Although margin trading is one of those means with huge benefits, its risk outweighs its reward. An investor’s chance of liquidating their accounts increases while trading margin, unlike short-term movement in the market. Yet, margin trading allows traders to add money to their portfolio, which is used for trading, and eventually make more returns. Margin trading has huge benefits, but only expert traders are enjoined to invest in it.