In the realms of finances, a Margin is basically a loaned deposit from a brokerage firm in order to trade or invest in a stock or asset.
An example would be if you were to buy $10,000 worth of shares. Normally, if you didn’t Trade on a Margin, you will have to buy it with exactly $10,000 of your capital. However, should you be using a Day Trading Margin Account with the margin level going up to 10% (do note that margin levels vary depending on a variety of factors from the asset to the brokerage firm itself), you could purchase the shares with just a deposit of $1,000.
Some of the popular brokerage firms that traders use for Margin Trading is through the services of GDAX Margin Trading and Robinhood Margin Trading.
Margin Trading and its Pros and Cons
While Trading on Margin is technically akin to trading in any other instrument, the main difference is that you can purchase securities in larger values than your initial deposit. In other words, when Margin Trading, it is similar to using the equity in your brokerage account as collateral for a loan. Do note that a margin account is usually required to do this. It is very important to have proper risk management and to make well-informed and well-researched decisions before attempting Margin Trading.
Your initial deposit is the only thing required to fund your account. However, in margin trading accounts. your allocated margin acts differently as it is funds belong to the brokerage firm. When you are margin trading, profits and losses are magnified which will conclusively have its impact on your allocated margin.
If through unfortunate timing or events occur and losses are generated way below the amount allocated as the margin, then you would go into what is called a Margin Call.
Here, you should either remit additional funds to maintain the position(s) or close them/it altogether.
Avoiding Margin Calls
When Margin Trading, it is important to always keep yourself in control of how much you are willing to risk within the market.
One of the best ways to avoid such a predicament while Margin Trading is to employ proper risk management and using orders such as Stop Loss Orders on open positions. This would likely result in a reduced initial margin requirement. If a Stop Loss isn’t secured, a further slippage of 20% of the total margin is superimposed to get the initial margin.
To illustrate this concept, let’s say that you are to buy 10,500 shares worth $10 per point. The Initial Margin Requirement will be $800 without stop loss as it is 80 times the stake.
Now, the Non-guaranteed stop loss placed at 10,460.
To calculate the Initial margin requirement will then be as follows:
10500 – 10460 = 40
= 40 x $10
+ 20% slippage (80 x 20%)
Slippage means that if the market value ‘gaps through’ the worth that your non-guaranteed Stop-Loss order is placed, then it’ll be crammed on the next available price.
= 16 x $10
This would make the total initial margin requirement ($400 + $160) =$560