Disadvantages Of Margin Trading: For most people, their journey of investing and trading starts with minimum capital. It could be because they don’t want to risk too much and are still learning to trade and invest.

It could also be because new traders and investors start with a mindset of being ready to face any losses and embrace any gains coming their way.

Margins changed this, making it easier to trade and invest with much more capital than traders and investors hold. 

Margin trading can be a great chance to make money in the market, but it can also be the quickest way to lose all your capital, especially if you overleverage and take the wrong trade.

So what is margin trading exactly? How does it work? What are the advantages and disadvantages of margin trading? These are all the questions we’ll be answering below. 

What Is Margin Trading?

Margin is the collateral given to traders and investors by brokerage firms. It gives them a higher purchasing power than their existing funds. It allows them to take up bigger trades than they could with their capital.

The brokerage lends the money to you for investing/trading. Investors use margin to make an investment and margin is the difference between the total value of the investment and the loan amount. 

How Does Margin Trading Work?

Margin is offered to traders by their brokerage firms. Using this margin to take up trades in the market is called margin trading. If traders choose to use margin, they must have a margin account.

A margin account allows an investor to use their cash and securities as collateral for a loan. Buying on margin refers to using borrowed funds from the broker to trade and invest in the market. 

The leverage from margins acts as an amplifier – It greatly increases the gains as well as losses made from trading. When traders make losses, a margin call will cause the brokerage to sell the securities pledged as collateral, without prior consent. 

Advantages Of Margin Trading

• Leverage: The first advantage of margin trading is leverage. Because of the increased purchasing power, traders and investors have access to more capital. So instead of trading and investing with their own money, they can do it with the collateral provided by the brokerage firm, which is much higher in value. 

• Magnified Profits: With leverage, traders have the opportunity to buy much more shares than with their own capital, which can greatly increase the profits they earn while trading. The huge returns that could be made in margin trading can be used to repay the collateral quickly. 

• Collateral Gains: By collateral gains, we mean the capital appreciation of the pledged securities. Over time, if the securities rise in value, people can use extra leverage, given that the collateral basis has increased. 

• Easy Of Repayment: Unlike other loans, collateral can be repaid easily, as the brokerage firm usually has all the client details in hand. Also, there isn’t a fixed schedule for loan repayment.

Disadvantages Of Margin Trading

• High Risk-to-Reward Ratio: While most traders enter margin trading because of the exponential gains, they tend to overlook the significant losses that one might face as well. Remember that margin trading is not free, and if traders lose capital due to a fall in security price, they need to pay back the collateral amount lent along with some additional amount. Brokers also charge interest on the collateral they provide to traders.

• Margin Call: The collateral provided to the brokerage, can undergo price fluctuations. In case the price of the securities goes against, the traders and investors who pledged the securities will face a margin call. A margin call is when the brokerage asks to deposit additional capital into the margin account if the value of securities has decreased substantially. In case of a margin call, traders should have additional funds set aside for the brokerage. 

•  Risk Of Liquidation: The biggest risk in margin trading is the liquidation of your collateral provided to the brokerage. If the trader cannot provide the additional capital, or if the price of the collateral drops substantially in a short time, the brokerage will be forced to liquidate the collateral. 

• Maintenance Margin: Another factor to consider is maintenance margin, which is the minimum amount that a trader must maintain before you they are asked to deposit more money into the margin account. 

Also Read: 10 Best YouTube Channels To Learn Share Market in India 2023!

In Closing

Borrowing funds by pledging securities comes with its pros and cons. To the expert trader, it provides a great opportunity to substantially increase the gains from margin trading.

For a beginner trader, it can be the swiftest end to their trading career. It depends on the skill and experience, along with the capability of the individual to repay the margin in the worst-case scenario.

Also, not every stock can be bought on margin. Before taking up margin trading, do read the advantages and disadvantages of margin trading before taking a decision. Happy Trading!

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