What are the pros and cons of trading on margin?
Margin trading is one of the most profitable areas of trading, but at the same time it involves greater risks than other fields, so how can the investor achieve balance and obtain profits without falling into losses?
One of the most important things that is said about trading on margin is that it greatly inflates profits and inflates losses to the same extent as well, as it is considered one of the areas most affected by external factors and events that disrupt the economy, but before getting to know the pros and cons of this field we must first ask the question what is Margin trading?
In a simple way, margin trading is based on borrowing from the brokerage company, to raise capital and be able to trade much more than you can do with your own money. From this definition, the first challenge for investors is evident in the margin, as they must achieve greater returns than the loan they benefited from. In order for them to start making profits, here we see that margin trading enables you to achieve free profits without entering with your own capital, but at the same time, if you suffer losses, you will be in direct confrontation with the brokerage company because of the repayable loan.
For this reason, we find that most of those who tend to trade on margin are giant investment institutions with experience in the field, such as mutual fund managers and hedge funds. To identify safe or less risky investments and at the same time have sufficient liquidity to face any potential losses.
What are the advantages of margin trading?
The negatives may have a severe impact on new investors and push them away from this field, but the positives are at the same time very tempting and attractive and may constitute a greater motive than the expected negatives.
Raise profits in emerging markets
Experts say that margin traders have a great advantage over their counterparts during periods of growth, as the margin account allows them to double their profits and make the most of the periods of increase, due to the fact that their profits are net and based on borrowed funds that can be repaid simply during periods of growth, but caution is necessary not to Nobody knows when the trading market will turn around.
Liquidity
In addition to the large profits, having a margin trading account is practical and very useful for investors, as it is a source of liquidity that is always available and easy to use. Unlike other trading accounts that impose on you a waiting period of three days between the sale process and getting your money, you can transfer the required value directly from the margin account in particular, so brokers advise all investors to own a margin account even if they do not intend to use it in trading operations
What are the risks of margin trading?
You could lose more than your initial investment
The biggest risk of buying on margin is that you can lose a lot more money than you initially invested. A decline of 50 percent or more on shares that were 50 percent funded using borrowed money equates to a loss of 100 percent or more in your portfolio, plus interest and commissions.
For example, suppose you buy 1,000 shares of Company X for $20,000 of your own money plus $20,000 borrowed in your margin account at a cost of $40 per share. That’s a total of 40,000 riyals, excluding commissions. The following week, the company reported disappointing earnings and the stock fell 50 percent. The position is now worth 20,000 riyals, and you still owe that amount to the broker for the margin loan. In this scenario, you lose all of your own money, plus interest and commissions.
You could face a margin call:
It is the event that all margin investors dread, as brokerage firms send requests to deposit additional liquidity into the margin account. This occurs in the event that the investor’s assets in the trading markets are exposed to large losses that exceed the value of the liquidity deposited in his account. In this situation, the brokerage firm will not be able to recover the value of the loan that was used in trading. You are forced to contact the investor and request the deposit of additional liquidity to cover the value of the losses collected.
In conclusion, you can rely on margin trading to invest and give a significant boost to your returns, but it is important to remember that leverage magnifies negative returns as well. But for most investors, trading on margin does not make sense and carries a lot of risk of permanent losses.
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