First things first, it is important to note that traditional Margin Trading in Forex trading and Margin Trading cryptocurrencies are two different things. Here we are looking at the former, and the regulations enforced by FINRA (Financial Industry Regulatory Authority).
Margin Trading is essentially using borrowed funds to purchase securities (bonds, derivatives, options, stocks). The key is that you need to have a percentage of the funds needed to make the purchase yourself but you do not need the whole amount as you can use a “margin” to make up the rest. The current minimum requirement of funds set by FiNRA, known as the initial margin, is 50% of the value of the purchase.
For example, if you wanted to purchase $1000 dollars worth of stock, you would have to have at least $500 of your own available.
This is Margin Trading in the most basic sense. In reality, there is a lot more to factor in when making the decision to buy on margin (borrow money) in order to trade on margin.
Terms and Concepts associated with Margin Trading:
Terms and concepts commonly associated with Margin Trading include:
- Margin Account: you need to have a separate margin account to engage in margin trading, you are not able to just use a standard brokerage (cash) account. This is similar to having separate accounts for your debit card and credit card. This holds the securities you buy on margin.
- Initial Margin: the amount of money that you need to have available to make a purchase. This is a minimum of 50% of the total value of the purchase according to FINRA. Some brokers may require more, this will be agreed upon when setting up a margin account.
- Maintenance Margin: also known as minimum maintenance or maintenance requirement. This is the minimum amount of your own money that needs to be available in your margin account after a purchase has been made. This is 25% of the total value of the purchase as required by FINRA. Again, some brokers may require more, up to 30/40%. If the value of your purchase increases/decreases, so will your maintenance margin.
- Margin Calls: this occurs when your own funds in your margin account are falling below the maintenance margin. The call is a warning to deposit funds into the account to bring the sum up to the maintenance margin. If you do not, the broker may be forced to liquidate the securities held in the margin account.
You can find a full list of more related terms here: Terms and concepts associated with Margin Trading
The Pros and Cons of Margin Trading
The pros: The greatest advantage of buying on margin is that it boosts your purchasing power and magnifies your wins. When you have a relatively small amount of money to work with; you can use margin to boost your returns or help diversify your portfolio.
The cons: The greatest con is also the same. Losses made on margin can also be magnified. When you sell your securities held in a margin account, any profits will first go towards paying back the loan to your broker, meaning you may not get your initial margin back if you made a loss. As with any loan, interest is charged that can accrue over time, making margin trading more suitable for short term investments.
Margin Trading with Phemex
Margin trading cryptocurrencies is similar to the above in that you are also borrowing funds to increase your buying power beyond the limits of your own account balance.
The main differences between the two are that the barrier to entry is lower and it is easier to start making profits with crypto trading. However, great losses are also equally easy to make as it is an extremely volatile market.
To read more about Margin Trading specific to cryptocurrency on a crypto exchange platform, Check out Bitcoin Margin Trading on Phemex.