What is margin trading and how does it work?

What is margin trading and how does it work?

2022-09-15 • Updated

What is margin trading?

Margin trading is borrowing extra capital from your broker for trading or investing. For example, imagine you want to buy a stock of Apple, which costs $150. However, you can not afford this investment and want to deposit only $15. That is ok! You can use leverage 1:10. It means you can invest only $15, and they will turn to $150. How? The rest of the money ($135) will be covered by your broker.

Leverage is a well-known tool that most traders use. In FBS, leverage is up to 3000. It depends on the account type and the trading instrument. 

Now that you know what leverage is, margin is easy! So, margin is a sum of money that is required to open a position. In other words, margin is the initial deposit of a trader which will be held as collateral by the broker. Margin is $15, the trader provides in case of using 1:10 leverage in the example above.

Benefits of margin trading

There are many advantages of margin trading which you can see as follows.

  1. Margin trading is perfect for those who do not have enough money to invest at the moment as it increases the buying power of a trader.
  2. It is a great tool that can help to get greater profits as the initial investment is larger with margin trading.
  3. Margin trading is especially useful in periods of low volatility as it allows expanding trading results.
  4. Traders can use it to open both long and short positions.
  5. Margin trading is helpful for diversification. Traders can open many various trades with considerably small amounts of money.

Risks of margin trading

Margin trading cuts both ways. It is crucial to understand that the potential for higher returns always goes with more risk. On the one hand, margin trading increases the potential returns significantly.

On the other hand, margin trading can magnify losses if the price does not go as a trader planned. Thus, it is vital for those traders that use margin trading to apply proper risk management and use risk-mitigation tools such as Stop Loss orders.

What is a margin call?

If one of your open trades is a losing one, your margin level will be going down, and to avoid losing all of the money, brokers use the so-called margin call. The margin call is a specific margin level (at FBS, it equals 40%) that, once reached by the trader, initiates a warning to make sure the trader either closes the losing trades or deposits more funds into the account.

What is stop out?

Once the margin level drops to the minimum allowed level or stop out level (at FBS, it is 20%), some of the trades, starting with the most losing ones, will be closed automatically to prevent the trader's negative balance.

Margin trading strategy

Margin trading allows you to increase the potential profits. If a trader combines it with proper risk and money management, it will place him or her in a better position and will help to take advantage of market opportunities and investment strategies.

Position sizing

Position sizing is a technique that determines how many units you should trade to achieve the desired level of risk. It is very important to choose your position size wisely. Here is the golden rule of experienced traders: risk no more than 1-2% of the deposit for 1 trade.

Control margin level

Pay attention to the parameter called “margin level”. Margin level is the number of times the used margin can be covered by the value of your account. It is the key indicator of how volatile your trading results are likely to be. The lower your margin level, the larger swings in equity you will experience. If your margin level is less than 500%, it means that you are probably taking too much risk on your account.

Risk/reward ratio

A risk/reward ratio is the amount of profit traders plan to get from trade relative to what they are risking in case of a loss. For example, if your Stop Loss equals 10 points and your Take Profit is 50 points, your risk/reward ratio is 1:5.

The risk/reward ratio to choose depends on your trading style as well as the market conditions (level of volatility, state of the market – trend or range). There is no universal solution here. We recommend keeping the reward higher than the risk for most trades. When trading in trend, risk/reward ratios can be 1:2 or 1:3. When you enter the market on a break of a specific level, it might be wise to choose 1:4 or 1:5 risk/reward ratios.

Margin trading example

For example, let’s say a trader deposits $10 and wants to open a long position in EUR/USD or, in other words, buy it. One lot is 100 000 monetary units in the base currency of the trade, in this case – euros. The minimum trading volume usually equals 0.01 lots or 1000 monetary units of the base currency. So, if a trader is buying EUR/USD, the minimum purchase is 1000 euros. However, if the trader is using 1:100 leverage, he or she needs to provide 1% or €10 (the broker will provide the remaining €990).

The change in currency value is measured in points. Depending on the currency, its volatility, and liquidity, different pairs can have different points: for EURUSD, one point equals 0.00001. For example, suppose some major financial event affects the value of the USD and it declines by 500 points. If the trader purchases 0.01 lots of the EUR/USD, their profit will amount to position size (€1000 for the smallest position available) multiplied by the number of points (0.00001*500).

If the trader has no leverage, they invest €1000 and profit $5 or 0.5%. However, if the trader uses the 1:100 leverage and conducts the same trade, their investment will be only €10, but the profit will stay $5, making it a 50% profit.

How to start trading with margin in FBS?

You have learned how to use margin trading to your advantage from the information above. To start trading on margin, follow the following steps:

  1. First of all, be sure you have downloaded the FBS Trader app or MetaTrader 4/5. FBS allows you to trade stocks only through this software.
  2. Open an account in FBS Trader or the MT5 account in your personal area. Make a proper analysis of the market and choose an asset of your interest: currency pair, stock, or commodity.
  3. Choose your position size and keep an eye on the margin level.
  4. Manage your risk properly with special tools such as Stop Loss and Take Profit orders, which can be especially useful in times of high volatility on the markets. Remember, though these tools do not protect you 100%, they help you minimize the possible risks.
  5. Open order and monitor it!

Bottom line

To be a successful trader, it is crucial to understand how to trade on margin properly. Margin trading is a powerful tool to increase your profit! However, it can magnify losses, that’s why remember to manage your risks more appropriately.

For beginners

If you are new to trading, a Demo account will be a perfect start for you as it allows you to train trading on margin without any risk. After you open it, you will get 10 000 virtual dollars and will be able to choose the amount of leverage.

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Frequently asked questions

  • How to withdraw the money you earned with FBS?

    The procedure is very straightforward.  Go to the Withdrawal page on the website or the Finances section of the FBS Personal Area and access Withdrawal. You can get the earned money via the same payment system that you used for depositing. In case you funded the account via various methods, withdraw your profit via the same methods in the ratio according to the deposited sums.

  • How to open an FBS account?

    Click the ‘Open account’ button on our website and proceed to the Personal Area. Before you can start trading, pass a profile verification. Confirm your email and phone number, get your ID verified. This procedure guarantees the safety of your funds and identity. Once you are done with all the checks, go to the preferred trading platform, and start trading. 

  • How to start trading?

    If you are 18+ years old, you can join FBS and begin your FX journey. To trade, you need a brokerage account and sufficient knowledge on how assets behave in the financial markets. Start with studying the basics with our free educational materials and creating an FBS account. You may want to test the environment with virtual money with a Demo account. Once you are ready, enter the real market and trade to succeed.

  • How to activate Level Up Bonus?

    Open Level Up Bonus account in web or mobile version of FBS Personal Area and get up to $140 free to your account.

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