Trading in financial markets involves a huge number of instruments; some are described to be more stable than others, while risky investments are more lucrative and can bring higher returns.
Risk-takers often trade with margin to amplify their gains with some elevated risks, but they must retain a sum equal to the variation margin.
This trading approach entails taking a significant risk, which is a make-or-break deal, causing the trader’s account to flourish or diminish substantially. Let’s highlight some key points of margin trading and how it is done.
What Is Margin Trading?
Margin trading involves borrowing money from the broker to capitalise on a more significant opportunity in the market, expecting better profits.
However, this approach is risky and may lead to becoming indebted to the broker and even liquidating one’s account if the market moves against your favour. Securing the maintenance margin entails careful calculation and planning of balance and equity.
Risk-taking investors use margin trading to explore market positions with high return potentials. This approach is often used when traders have limited equity in their accounts and want to leverage their market position, taking on unmissable market opportunities.
For example, a trader might predict that Apple’s stock price will increase upon a new product launch and want to purchase 100 shares, each at $200. However, they only have $1,000 in their account, so this market order will cost at least $20,000.
Understanding Maintenance Margin
The maintenance margin (variation margin) is the amount of equity a trader must keep as collateral, which indicates how much money remains in the account before the broker issues a margin call.
A margin call occurs when the leverage trade drops in value and reaches the variation margin amount, ordering the investor to add funds to support the trade before liquidating the position.
Each market order has a unique maintenance margin determined by the broker’s structure and rules, which must be carefully maintained to keep an open position.
The variation margin requirement can be used as a risk assessment tool, indicating the hazard of the trade proposal and what to expect if the market moves in an unfavourable direction. Therefore, thorough calculation and analysis must be conducted beforehand.
How to Calculate Maintenance Margin?
Maintenance formulas for the variation margin include the following formula:
Variation Margin Level = (Position amount * Average entry price * Variation margin rate) + Assumed commission for closing the position.
Another formula is:
Average Position Price =Total contract value / Total transaction amount.
Conclusion
Trading with margin is a risky strategy that involves borrowing money from the broker and exploring highly risky market positions. This approach must be handled with care, including several calculations and considerations like maintenance margin and amount in equity.
Therefore, there might be better options for beginners, while risk-takers prefer this method to amplify their potential gains.
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