Margin Trading, Definition, How it Works and The Pros and Cons

margin trading

For ordinary people, the term margin trading may sound foreign, but it is not for stock investors. Talking about stock trading, the availability of a large enough fund is necessary. This is because buying shares is not just a sheet or two, but in lots, where one lot equals 100 shares, while the share price is calculated per share. Therefore, the capital needed to 'play' stocks is quite large, it can reach tens or even hundreds of millions of rupiah.

However, currently, investors do not have to worry about the limited capital they have. This is because there is a margin trading facility that is ready to cover purchases of stocks with good performance. What exactly is meant by margin trading?

Margin trading for stock investors is considered a facility that makes it easy and at the same time easing the process of buying shares. Stock trading on margin trading is facilitated by securities companies.

Definisi Margin Trading

Margin trading is a method of trading stocks using funds provided by third parties (securities company  - broker). As a trading method, margin trading is used in buying and selling shares where the funds used to buy the shares come from loans made by securities companies to investors.

In terms of securities companies, margin trading is a facility provided for investors who are their customers. This margin trading facility allows investors to buy shares in larger quantities than they should. This means that borrowing funds from securities companies to investors will of course increase the capital that will be used to buy shares.

The margin trading facility provided by securities companies to investors who are their customers is certainly not without collateral. Stock trading using the margin trading method is secured by collateral in the form of shares in the investor's account.

The term margin trading is not only used in stock trading but also in forex trading. The definition of margin trading in forex trading is the same, namely the trading method using borrowed capital. Margin trading in the forex market is measured in units of value which refers to the transaction value. For example, $10 in the margin trading system can be transacted with smaller funds,  0.5% of the original value, or around $5. This can happen because forex trading does not involve the physical eye. Currency buying and selling transactions need not be made with physical money, but only in value. Forex investors only need to provide the necessary money as collateral for transactions, and this guarantee is then called margin in forex.

How Margin Trading Works

The margin trading facility allows investors to buy shares beyond their capital capacity because part of the capital is obtained from loans from securities companies where the investor in question opens an account or becomes a customer.

How does margin trading work? Capital loans for stock trading purposes are certainly not the same as capital loans in banks in general. When margin trading starts, investors will be asked to determine the margin percentage of the total order value. This is related to the concept of the leverage ratio, which is the ratio or comparison between investors' funds and loan funds from securities companies as brokers.

Margin trading accounts are used to make leverage trading, which describes the ratio of borrowed funds to margin. As an illustration, for example, to open a trade of $10 with a leverage of 10: 1, the investor must provide a capital of $1.

The level of leverage in margin trading offered for each stock trade differs. The typical ratio for the stock market is 2: 1, whereas futures contracts are often traded at 15: 1 leverage. Meanwhile, for forex trading, the leverage ratio offered can reach 50: 1, even in some cases 100: 1 and 200: 1. However, the commonly used leverage ratios range from 2: 1 to 100: 1.

Margin trading can be used to open buy and sell positions. A long position reflects the assumption that the stock price will increase, while a short position reflects the opposite. Meanwhile, the open margin position reflects stocks which are assets of investors acting as collateral for loan capital. This is important to understand by investors, because securities companies as brokers or brokers have the right to force the sale of shares which are investors' assets if the market shows movements that are against their position, of course within a certain threshold.

When the loan matures, stock investors are required to pay off margin debt following applicable regulations. This is also known as a margin call, wherein the investor must deposit funds into his / her margin account to reach the minimum margin trading requirements. Besides, investors will also be charged with loan interest. If investors default or fail to pay their debts, their ownership of the assets in the form of shares will automatically be liquidated to cover their losses. As a consequence, assets owned by related investors will be forced to sell (force sell).

Profit and Loss on Margin Trading

Stocks are one type of investment that has a high risk and a high rate of return (high-risk high return). This also applies to buying shares using the margin trading method. Investors have the opportunity to get a greater level of profit because the relative value of their trading positions is greater.

Not only the profit potential, but buying shares with margin trading can also be used as asset diversification, where investors can open several positions with a relatively small amount of investment capital. This method of margin trading allows investors to have margin accounts that make it easy to open positions quickly without having to transfer large amounts of money to their accounts.

Not only profit opportunities, but margin trading also has the risk of loss. Any decline in share prices even if they are relatively small in the stock market can cause huge losses for investors. Therefore, to minimize the incidence of losses, investors are required to be able to implement risk management strategies and use appropriate risk mitigation tools.

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