This article was contributed by Daniela Ešnerová who works as a financial journalist for Capital.com.
Some traders understand the rudiments of Forex trading and can identify the entries that will make them profits but do not have enough capital to kick-start their trading journey.
To help such traders, brokerage companies provide them with enough money to add to their capital to make a substantial amount with the combination of the two, known as Margin. However, since there is no total guarantee that the trader will make profits from the trade, the broker needs assurance that the trader will refund with interest.
Leverage is when traders use Margin to trade. The loss or gain of traders can increase with leverage generated from Margin. Due to their similarities, newbies in the trading realm usually find it difficult to differentiate between Margin and leverage. If you are a newbie, this guide will help you find a solution to your dilemma.
Meaning of Margin Trading
When traders are short on capital, they open a margin account and fund it with their available funds. They then ask the broker for a loan to supplement their initial cash so they may start trading with it. The difference between the trader’s entire current holdings and the loaned sum is known as margin.
Margin trading is a process for borrowing money from brokerages using certain assets. The minimal margin is the trader’s start-up money, the initial margin is the sum used to complete a deal, and the maintenance margin is the balance left in the account.
Margin calls occur due to the inability of the trader to pay back the borrowed money after the amount in the margin account is less than the maintenance margin. The investment gets liquidated unless the trader refunds the loan or makes more deposits into the account.
Meaning of Leverage Trading
You need to borrow money when you have a project without enough funding for its completion. Doing so is known as leverage, and many organizations’ aims have been achieved through it. Companies increase equity valuations and execute many projects with leverage, whereas traders use it to amplify their returns. Mathematically, the ratio of the amount invested to the amount available for trading after borrowing.
For instance, if the amount spent is 1 000 dollars, whereas the amount available after borrowing is 100,000 dollars, the leveraged trade is 1:100. Since trading is not one way, there is also the possibility of the trader losing a huge chunk of money.
What Differentiates Margin Trading from Leverage Trading?
Although many traders use leverage and Margin interchangeably, they differ in certain cases. The context in which both tactics are used can showcase their differences. Below are some cases where they differ:
- The main disparity between the two entities, which is applicable in many contexts, is that when borrowing, the degree of the buying power the trader can afford is indicated by leverage.
- Using the initial amount deposited into the margin account as collateral, traders request money from the broker, which will be with interest when returned. This is what margin trading entails, unlike leverage, although they are both investments.
- Traders can execute meaningful trades using borrowed money, the collateral in leverage trading.
- Regardless of the interrelationship between Margin and leverage, traders can generate leverage through other means besides margin accounts. These other means are not in any way related to margin accounts.
- When the liquidity in the market is high, traders tend to get high returns by investing in Margin for a short period, unlike leverage, whose investments are better on a long-term basis such that the losses of the traders reduce.
Experienced Forex traders use margin accounts when they want to trade with leverage. But if you are a beginner, it is best to avoid the strategies and tactics until you fully grasp how to leverage trading operates. Some traders mistake leverage for margin and vice versa, making it difficult to distinguish between the two.
In order to distinguish the distinctions, they must take into account their applications and the situations in which they are employed. The gains and losses of traders can both be amplified by leverage and margin trading. Also, ensure to register with a reputable and credible broker to secure your investment.
About the author
Daniela Ešnerová is a Czech, London-based financial journalist with eight years of experience, including working in various streams of the UK’s financial press and the Czech edition of Forbes, as well as brief stints at Czech national TV and radio channels. She currently covers cryptocurrencies and equity markets. Daniela also has a specialization in retail investment and the asset management market. Daniela holds a Masters’ Degree in Business and Finance Journalism from City University.