What Is Margin Trading? Welcome Leverage!

How many times in life has anyone struggled to open a bottle or unscrew a cap or loosen a bolt and never had the strength to do it themselves? The trick always is to use something to leverage it open or loosen it, either through giving it to your partner or using a tool or bigger tool to be able to use less strength to open the specific lid. Very few people know that this is also possible in investments. Using "borrowing" to be able to do more with the amount of funds that you have.

Margin trading is where an investor use "borrowing" through a broker to leverage themselves into bigger positions. So how do they achieve this? The funds that you have available you use as a cash deposit and the remainder of the position gets financed through a loan. Eg. if you have 20$, you can use the 20$ as a deposit to open a 100$ trade by borrowing the remaining 80$ and using the asset bought as collateral. This is called leveraging yourself into a bigger position.

This cash deposit is the initial margin required to open the position and varies based on the instrument and market traded. The lower the margin requirement on an instrument the bigger the leveraged position is that you can open. To keep this position open the client will be required to maintain a minimum amount of equity on the account. When the price of the asset increases this will increase the amount of equity on the account since the market value of the stock increases in proportion to the borrowed funds, meaning that the investor's free equity increases. In contrast, if the price of the asset moves against your position this will reduce your equity on the account.

All brokers require a minimum maintenance margin on open positions to protect themselves in case of a price decline. This maintenance margin is the value of the total equity on the account in proportion to the value of the asset. If the asset price drops enough that the equity reaches a minimum amount equal to the maintenance margin the broker initiates a margin call and closes the position and in turn sells the asset to pay back the loan that was used to leverage the position and you receive your cash deposit back.

In short, with margin trading you can open bigger trades with less funds however your risk is also magnified since your trades are much bigger compared to the funds you have. You will be required to have a minimum amount of funds available on the account to keep the position open. If you lose too much on a position in relation to how much funds you have in the account, then the broker will close the position and allocate the losses as required. Be very vigilant when trading this form of investment.

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