Many beginners make mistakes. That’s a standard part of learning process. But those mistakes can be costly if you get involved in margin trading without understanding the risks it carries. Below we’re going to explain how it works and which risks it carries.
How Does Margin Trading Work?
Margin trading is simple and appealing to many traders. Buying on margin can be defined as borrowing money from a broker to purchase goods, stocks, currencies, etc. By getting a loan from your brokerage, you can get more stocks than you’d be able to normally. Here’s an example:
You’re expecting a rise in the price of a certain altcoin, but you only have 2000 US dollars. If you had more money to invest, you could get higher profits. Margin trading is the easiest solution – after you deposit 2000 dollars, you’re allowed to borrow up to 50 percent of the deposited amount. So now you can have 3000 dollars to invest. Of course, you can borrow less, 10 or 25 percent of the deposit if you like.
If the price of the altcoin you bought goes up, you’ll be able to repay the loan and still keep a nice profit for yourself.
The Risks of Margin Trading
The thing many beginners don’t understand or tend to neglect is what happens if your investment goes wrong. Below are a few things users need to think about when starting margin trading.
Maintaining a level of equity
The trading platforms always require traders to maintain a minimum level of equity which is typically set at 30 percent.
If your balance falls below this, you’ll be required to deposit additional funds to the account in order to increase equity immediately. If you fail to deposit more money or simply don’t want to, the brokerage will close your positions to increase equity in the account.
Interests Can Surpass the Profits
Trading on margin can be profitable if it’s used for short-term investments. In case that you invest the money and the anticipated jump in value don’t happen, think about cutting your losses and paying the short-term interest. Keeping your margin trading position open for a longer period can result in losses even if your stocks’ price increases. Why?
Margin trading comes with significant interest rates, and in some cases, the profits are not enough to cover the costs of long-term loan you took.
You Could Lose More Than You Have
Margin trading doesn’t magnify the profits only, it magnifies the losses as well. In case that things go wrong, you’re not only going to lose your investment but also find yourself in red as you’ll have to repay the money you borrowed to the broker and pay the interests.
This means that if you’re not careful, you could end up in debt.
You’ll also have to consider the fact that margin accounts are more sensitive than standard trading accounts to day-to-day market fluctuations. This adds a certain dose of unpredictability to the margin trading.
Investing on margin is only profitable if your investment allows you to pay back the loan with interest.
If you’re considering margin trading, consider starting with baby steps and learning by experience. Margin trading can be a valuable tool if you’re able to cut the risks to the absolute minimum.