Margin is capital used to purchase assets that don’t belong to the trader. It is the net difference between the value of a trader’s account and the funds borrowed from the broker.

This practice allows traders to use greater sums of capital to apply leverage to their positions, effectively amplifying profits and losses. So although the extra profits are attractive to traders, this does not come without added risk.

How Does Margin Trading work?

When a trader places a margin trade they must work within the constraints set by their broker. This will depend on their creditworthiness and the market they are trading. 

In the stock market, for example, 2:1 is a normal ratio(also called 50% margin), where a margin trade of $2,000 will require $1,000 of capital. In the forex market leverage of 50:1 up to 200:1 is frequently seen. For futures contracts around 15:1 is typical.

This method can be used for both long and short selling. This ability to trade on an asset growing in value or decreasing gives traders more chances to profit than simply buying physical stock and holding onto it.

The Dreaded Margin Call

Although being able to make more profitable trades sounds great this does increase the chance of a catastrophe in the future. If things start to go wrong the broker may call the trader to demand they invest more capital into the account. This is known as a margin call. Something every margin trader dreads.

If the trader does not meet the broker’s requirements in good time the broker has the legal right to close open positions. Which positions are closed is completely at the discretion of the broker, potentially causing even worse losses for the trader.

Risk Management

Risk management is a crucial part of day trading. No matter what the market or the amount at risk. Any trader attempting to profit must take precautions to prevent the loss of their capital.

Stop-limit orders are one such strategy that uses pre-programmed values to automatically trade out of open positions, regardless of if the trader is monitoring the market or not.

The risks in the cryptocurrency markets is even a level higher than the regular markets. The increased volatility typical to bitcoin and all manner of new currencies is not an environment for novice traders. Any trader considering opening positions in the cryptocurrency markets should have already cut their teeth with regards to fundamental and technical analysis. Margin trading cryptocurrency prices is for experienced traders only.

Margin Funding

As we have seen, margin trading is inherently risky, and not suitable for everyone. But if a trader has a low tolerance to risk they can still get involved, through what is known as margin funding.

Some brokers allow regular traders to use their capital to fund other more experienced traders who trade on margin. This loan earns interest but the terms will differ from exchange to exchange.

Summary

Margin trading is a standard part of a trader’s toolkit. It should be obvious by now that it is not for novice traders but something for the more experienced. Used correctly it can dramatically increase the speed at which an account grows, but the reverse is also true. Used poorly the trader stands to lose everything in a short timeframe.