| Margin is essentially collateral for a position. It allows traders to take on leveraged positions with a fraction of the equity necessary to fund the trade. In the forex market leverage ranges from 1% to 5%. An investor taking advantage of a 99% leverage facility will only be required to pay a deposit of $1000 to take a position in 100,000 euros. In this arrangement, the broker charges interest on this loan (in addition to the commission on each buy/sell trade) and the investor has to keep the entire amount with the broker as collateral. Also, the investor has to put up additional cash in case the value of margin money falls below a certain amount.
ADVANTAGES OF MARGIN TRADING
- Increased buying power with minimal investment.
- More profit with less investment.
- Flexible margin facilities that allow investors to borrow upto 100% of their initial equity
- Greatly suitable for short-term investors, who trade with high volumes.
- Suitable for sophisticated investors, having knowledge of financial market trend patterns.
DISADVANTAGES OF MARGIN TRADING
- A dual-edged sword; similar to the magnified effect on gains, losses can be more acute.
- There can be overnight interest due on the amount borrowed
- The account balance and buying power changes with change in prices.
- The chance of margin call is always prevailing.
- Investors are obliged to maintain a minimum amount in the margin account, called the maintenance margin. Any fall below this level prompts a margin call.
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