Margin in trading is that kind of facility offered to traders to utilize the availability of higher funds with a certain amount of deposit. This means, using the margin trading facility (MTF) you can get access to utilize the funds much more than a fund you have deposited as margin money.
To use this facility you must have to deposit the minimum amount and keep maintaining the margin requirements as per the margin call by your broker. This kind of leveraging in trading and investing helps to borrow funds from your broker and enter into large trade positions. Though, it can allow you to leverage your investment for higher returns at low cost, is it good or is there any risk involved in margin trading?
Is it good to Use Margin Trading?
Using the margin in trading is good in terms of providing you the facility to get funds higher than you have at that point of time. Using this margin, you can enter into a higher trade positions and when you earn the profit, you can exit from your trade position or liquidate your investment to pay the interest on margin amount you utilized. However, using the margin trading could be also risky.
Suppose you have borrowed five times the margin on your funds you have deposited, and if the market does not move as per your expectations or the underlying security you trade goes opposite to your expectations, then you can indulge in huge losses. This can cost you not only in terms of losing your money but you also need to pay the interest on the amount you borrowed from your broker.
What kinds of risks are involved in Margin Trading?
Apart from paying the interest on borrowed money and chances of incurring huge losses, due to the facility to trade in large positions there are certain other types of risks involved in margin trading. Let’s find out what are the other risks of margin trading and how you can deal with such risks to minimize their impact.
Risk of Leveraging: The MTF allows you to trade with funds exceeding your own financial capacity by borrowing from your broker. However, this comes with higher interest costs and an increased risk of substantial losses. You are required to repay the borrowed amount to your broker, using your margin, irrespective of the outcome.
Unable to Meet Margin Call: When the value of your trade position drops due to a fall in the price of the underlying security your broker will call you to maintain the minimum margin ratio. Here in case of a sudden margin call and unavailability of funds, you can attract margin penalties.
Risk of Liquidation: While on the other hand, if you are unable to maintain the margin calls, the broker and exchange have the power to square off your trade positions or liquidate some of your trades by selling the securities without your approval or prior notifications.
More Flexibility to Trade: This facility is available for both types of trades, long as well as for short. Hence, if you use the MTF for short-selling and the underlying security moves abruptly in the opposite direction, then you incur huge losses with the interest cost of borrowing and the chances of liquidating your positions.
Margin Trading Risk Management Guide
Leveraging your investment, using MTF can lift your return on investment but at the same time also poses risks that you need to control or minimize its impact. Margin at risk in trading comes with this facility but with the right strategy of margin trading risk management, you can make better use of MTF. It will not only help you to make better use of such funds but also avoid the potential risks involved.
Evaluate Your Risk Appetite
Before you utilize the margin money or enter into any high-risk trades or short-term investments, you need to perform the risk appetite assessment. Here you need to evaluate your investment goals, how much funds you can afford to borrow, and how much risk you can take while entering into such trades.
Use the MTF Calculators
This is a very important tool you should always use to know the exact amount you need to deposit as margin money to avail the MTF. This will also help you to know how much funds you can borrow from your broker, interest rates and breakeven point to enter into profitable trades.
Trade Only After Research
Trading or investing in the stock market or any other underlying securities without researching is like playing a blindfold game. Here for intraday trading perform the technical analysis and for short-term to medium-term investments you need to go through the fundamental analysis. The research using various tools and techniques will help you to maximize your chances of profitability and minimize the risk of losses.
Diversify Your Investments
Trading in single-type assets or investing your money in one sector or industry could expose your portfolio to the risk of unsystematic risks. Here you need to diversify your investment to get balanced returns. Avoid trading only in high volatile or only high volume stocks or entering into multiple types of trade positions.
Trade with Stop-Loss
Trading with stop-loss is one of the best risk management trading strategies that helps to reduce potential losses. While entering into the trade position, identify the right stop loss point, so that you can protect your capital from unnecessary losses that can cost you more if invested through MTF.
Stop Overleveraging
The leveraging is offered for your benefit to get access to high trade values even though you don’t have funds sufficient at that point in time. But misuse of such facility or overleveraging beyond your financial capabilities can wipe out the significant amount of your capital from the market.
Monitor Your Trade Position
Merely entering into the trade position would be not enough to earn profits. You need to keep an eye on your trades and keep adjusting your trades as per the changing market conditions. Using MTF for intraday trading should be closely watched to take advantage of any significant moves or exit from your trade position timely.
Don’t Underestimate the Volatility
Volatility is one of the biggest enemies in trading especially when you trade in the option market. When the market is highly volatile, avoid using the MTF to trade in the market or the underlying security trading with high implied volatility. Even slight moves in the spot market can affect the option price of the underlying security which is already influenced by various other factors like option Greeks.
Concision: Is Margin Trading Right for You?
Margin trading can, of course, offer a leveraging facility to enter into high-value trades by depositing some portion as margin money. You can use this for intraday or short-term trading in futures and options, but keep in mind the risk involved in trading with a margin trading facility in all the market segments.
High leveraging means also major losses if the market does not move as per your expected direction. Either maintain the margin money to hold your position to become in profit or exit in the losses otherwise you can face the margin penalty. Hence, evaluate your risk appetite, fund availability and investment objectives before using the MTF. And trade with the right margin trading risk management strategy to avoid losses.
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