What Is Leverage And Margin Trading?

June 13, 2022
leverage and margin trading

The availability of leverage attracts numerous traders from across the globe. Besides, leverage is a significant reason many people trade forex more than the other available financial instruments. The traders usually receive high leverage in forex trading; therefore, many people go ahead with it. Howe, it is significant to learn and understand the general meaning of leverage before proceeding further with the investment. 

Understanding leverage

Leverage refers to applying borrowed funds to enhance the comprehensive trading position. Other than the cash balance, many traders prefer leverage to diversify their portfolios and provide a stable financial position. Generally, the leverage is applied via margin trading. Once the leverage is used, the traders benefit financially even from the slight price movement. However, all those glitters are not gold because the leverage holds the position to magnify the profits and the losses. 

Interpreting leverage

  • Leverage includes renting some funds for further investment. 
  • Generally, the money is rented from a broker in forex trading. 
  • Therefore, for the initial margin requirements, the traders receive an amount. Thus, the trader can build more money. 
  • Margin-based leverage can be calculated by dividing the total transaction value by the margin amount. 

Understanding Margin

Margin refers to the collateral the trader deposits with another party while holding the financial instrument to overcome the risk. In general, it overcomes the credit risk and therefore, it is a method of protection. In other words, the traders can purchase more financial securities with the money borrowed and thus, the overall funds enhance significantly. 

leverage and margin trading

Characteristics Of Margin Trading

Following are the underlying features of margin trading:

  • Magnification of both profits and losses: The general characteristic of margin trading also magnifies the losses. Therefore, it can also turn harmful if misapplied.
  • Low Balance: The traders must maintain a minimum balance in their accounts for applying margin trading. In other words, a significant capital portion is always locked, and therefore, if the minimum balance is not maintained, the traders may not get the facility of margin trading.
  • Asset liquidation: If margin trading is not applied ideally, the broker has every right to liquidate the assets. Hence, the loss will turn massive, and the traders will lose their money. Therefore, the traders need to maintain a minimum balance, as mentioned above. The minimum balance will lead to the margin call, thus safeguarding the traders. 

Also read: What Is An Offshore Brokerage Account?

Benefits Of Margin Trading

If applied ideally and with complete planning, margin trading is also beneficial. Here are some of the excellent benefits derived from margin trading:

Video Source : Financial Wars

  • Short profit generation: Traders seeking profits from minor market movements benefit from margin trading. The margin trading keeps into account the small market and price fluctuations. Therefore, the traders earn profits and higher returns.
  • More returns: The overall income of the traders increase via margin trading. Thus, the traders can enhance their returns on the total invested capital. 
  • Safety and security: Margin trading is regulated and controlled by SEBI. Therefore, the traders need not worry about the investment and other capital. Their money is safe and secure under the guidelines and constant control of SEBI. 

However, as mentioned before, all that glitters is not gold, and therefore, margin trading also highlights some downsides. The best brokers with high leverage are listed here, as are the pros and cons of margin trading, as well as global regulation.


Demerits Of Margin Trading

Following are some demerits of margin trading:

  • Prone to risk: Margin trading is highly prone to risk. The trouble is that the traders can lose more money than their initial investment. Hence, the loss may double if not implemented well.   
  • Requires minimum balance: The primary requirement of margin trading is that the traders must maintain some balance in their accounts. The amount is called the minimum balance, and the traders must retain it. If the minimum balance is not maintained, the traders may have to sell some financial instruments and maintain the amount. 
  • Liquidation: Liquidation arises when the traders fail to retain the minimum balance in their accounts. Therefore, in such a case, the brokers sell the financial securities leading the trader to liquidate their account. Hence, the traders may amplify their losses significantly, leading to liquidation and more financial loss. 

The Bottom Line

Therefore, in a nutshell, it is imperative to understand that margin trading is packed with both merits and demerits. It is suggested that the traders holding vast knowledge of the forex market must go ahead and apply the concept. For inexperienced traders, it is best to stay away from margin trading.

Author Dave