Trading on margin is tricky.
Margin is something like a deposit that builds trust. It is can also be compared to collateral if something terrible happens in a trade. Brokers ask for margins to keep a position open. It is considerably related to leverage that sometimes people get confused with the two.
Imagine this: you can open a position worth $100k with only $1k. The rest of the money is all borrowed. In this example, the $1k is the margin. It allows a person to open a comparably significant position with zero to little money of your own. It can act in the form of leverage, but it cannot stand alone as leverage. Your account balance will be the basis of the maximum position size that you can open.
If you have a margin, your buying and selling power increases. In our previous example, you opened a $100k position with only $1k.So, your leverage ratio is 100:1. Hence, if you have $5k, you can have more buying and selling power. If we use a 100:1 leverage, you can control a position as big as $500k with only $5k. More buying power means a more significant potential profit. However, it also means a more considerable possible loss.
The margin call
A margin call is something that any person who is trading on margin fears and hates. It happens when your margin deposits are already below the minimum level that you need. So, your broker will notify you that your open position is moving way against your favor.
A trader should consider all the factors first before going through with trading on margin. If you plan to do it, discuss it with your broker, know even the tiniest details, and develop a margin agreement. Ensure that you truly understand how these types of trades work.
What happens if you receive a margin call?
Brokers have different margin requirements. It’s also different for every currency pair. However, if your margin went below the requirement, liquidation or a partial liquidation may happen. Sometimes, liquidations can also occur even when you did not receive the margin call yet. It means that your broker might be forced to close some or even all of your open positions so that your account balance will not go deficit even when the market is unpredictable and volatile.
Here is what you can do:
Maximize the use of stop-loss orders on all of your open positions. Always keep an eye on your account balance so you won’t have to receive a margin call. The only downside of stop-loss orders is that they can have slippages in highly volatile situations.
Should you trade on margin?
Trading on margin can only lead to two things: a profit or a loss. It’s just like any other trade. If you are interested but scared of risks, know that every trade has its fair share of risks. However, if you do so, make sure that you understand every aspect of the trade. Know your broker’s policies and the risks you are ready to accept. Let’s cap off our lesson with trivia. Margin is usually higher on the weekends.