Margin Trading
With Margin trading you can trade on a small amount of money.
Trading on margin allows traders to take advantage of trading opportunities without having to worry about a huge capital investment to acquire an asset.
Margin trading, on the other hand, entails using leverage to raise risk and potential returns. Margin is usually expressed as a percentage of the size of the forex positions and varies per forex broker. In the forex market, a 1% margin is common, meaning that dealers can control $100,000 of currency with just $1,000.
Calculating Margin
The margin for a forex deal is calculated using a simple method. Simply multiply the trade size by the margin %. Then, from the remaining equity in your account, remove the margin utilized for all deals. The resulting figure is the amount of margin you have remaining.
Calculating Margin Example
Example:
Suppose you want to borrow $30,000 to buy a stock that you intend to hold for a period of 10 days where the margin interest rate is 6% annually.
To figure out how much it will cost you to borrow money, multiply the amount you want to borrow by the rate you’ll be charged:
$30,000 x .06 (6%) = $1,800
Then divide the result by the number of days in a year to get the total. Rather from the expected 365 days, the brokerage sector typically employs 360 days.
$1,800 / 360 = 5
Multiply this figure by the total number of days you’ve borrowed or expect to borrow the money on margin:
5 x 10 = $50
In this case, borrowing $30,000 for 10 days will cost you $50 in margin interest.
While margin can be used to increase profits if the price of your investment rises and you make a Leveraged purchase, it can also increase losses if the price of your investment falls, resulting in a margin call, or the need to add more cash to your account to cover those paper losses.
Remember that whether you profit or lose on a trade, you will still owe the same margin interest as the original transaction.
Final Thoughts
Trading on margin is a risky business, but can be profitable if managed properly, and more importantly, if a trader does not overleverage themself. It also makes accessing certain asset values easier as a trader doesn’t need to put up the total cost of an asset when they see an interesting trading opportunity. When entering a trade on margin, it’s important to calculate the borrowing cost to determine what the true cost of the trade will be, which will accurately depict the profit or loss.
