Investing in the financial market is becoming more accessible thanks to the development of electronic trading platforms and reliance on digital communication that facilitates order execution within seconds.

Brokerage companies offer more ways to diversify an investor’s trading portfolio, engaging in high-value positions, even if they do not have enough capital. How is that done? Margin trading is the answer!

In short, margin trading means the trader’s ability to marginally cover their investment while the broker funds the remaining amount. However, several complexities and challenges arise with this technique, so let’s review them.

Cash Accounts vs Margin Accounts

Traditional trading entails using the available balance in the trader’s account to buy stocks and assets and execute market positions. However, margin trading entitles the trader to more benefits and services offered by the broker.

Margin accounts allow investors to use the broker’s funds to process market orders, especially when the position requires a significant investment. Investors use this technique to increase their chances of multiplying profits at amplified risks. Therefore, this strategy requires careful consideration.

With margin trading, investors can use the broker’s leverage to cover a significant part of the trade while the user covers a small margin. This leverage is determined by the broker as a ratio from the position value.

For example, if a broker offers 1:100 leverage for $10,000 worth of investment, the trader spends only $100 from their balance. In other words, the broker doubles each $1 by $100, allowing clients to execute the mentioned order using only $100.

Margin Trading Elements

Trading on margin is a risky tactic because if the trading session does not end successfully, the trader has to repay the debt. To combat that, brokerage companies introduce margin account requirements, such as minimum, initial and maintenance margins.

Minimum margin: the investment amount paid by the trader.
Initial margin: the amount funded by the broker.
Maintenance margin: the amount to be held in the trader’s account as collateral.

The rules on the amounts required per each leveraged trade are defined by the broker depending on the security, asset class and market volatility.

Expanding on The Maintenance Margin

The maintenance margin is the amount that must be kept in the trader’s balance after the leveraged trade is executed. The broker requires this amount as a percentage that must be available. Otherwise, the broker will call a margin call.

This collateral works as a guarantee for the broker in case your margin position defaults, safeguarding the provider from excessive losses. However, the trader becomes indebted to the broker, who may recover this amount from the trader’s available assets and equity.

Once the margin call happens, the trader must add more funds to the account to increase the balance to the required percentage. In other words, to maintain the margin trade.

Calculating the Maintenance Level

This strategy is usually followed by wealthy investors who can afford such trades or can lose such amounts. Additionally, risk-takers also prefer this tactic to amplify their chances of landing the jackpot.

However, maintaining the margin order is important and knowing how to calculate it is crucial. This is how you can do it.

Average Position Price = Total Contract Value / Total Transaction Amount

This formula is used to determine the cost of a margin trading order.

**Variation Margin Level = (PA * AEP * VMR) + AACP**

Whereas:

PA – position amount.

AEP – average entry price.

VMR – variation margin rate.

ACCP – assumed commission for closing the position.

Margin Call Price = Purchase Price (1 - initial margin / 1 - maintenance margin)

This formula is used to determine the price at which the broker’s call will occur, demanding the trader to add more funds to maintain the leverage position.

Final Takeaway

Margin trading entails borrowing the broker’s money to fund high-value positions, which can potentially amplify the trader’s returns. However, this risky tactic comes with multiple challenges.

An investor must maintain a fixed percentage of the position value as an available balance to keep the trade running. Additionally, if the order faces insolvency, the broker may liquidate the user’s equity and assets to recover from the losses.

Therefore, it is a risky trading strategy that requires thorough planning and calculations, making an advanced approach to investing in financial markets.

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