In this article, we will look into trading. To be more precise, we’ll study about What is Margin in Trading? If you are a trader, you may have heard the term or maybe be familiar with it. It’s trading with borrowed funds in future contracts.
What is Margin in Trading?
In trading, Margin refers to the capital that the investor has to deposit towards their broker as a sum of guarantee or security. This is because the broker has the default risk, to protect themselves, they take the security deposit.
The margin usually has a scope of 5%-20% of the stated value of the future contract.
For example, if an investor wants to trade in shares of $1000, and they opt for margin trading due to insufficient funds. So, the investor would be provided with the amount by a broker or a brokerage firm provided the investor has an approved account from the Marginal Trading Facility.
If they do, then the broker or the firm has to pay up a certain amount of security fund for collateral in case of losses. Let’s assume 10% i.e. $100, and the rest $900 would be provided by the firm or the broker.
Along with the security funds, the investor will have to pay interest on the borrowed capital.
Next up after what is margin in trading is the types of trading.
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Types of Margin
Now that we are aware about What is Margin in Trading, let’s look into the types of margin. Margins differ on the basis of time period in which they are to be paid.
Let’s discuss them below,
- Initial margin
- Maintenance margin
- Variation Margin
Initial Margin
Initial margin refers to the deposit made at the starting point of the contract. This is a deposit that has to be paid by both the parties – Long and short position holders. This is to make sure both the parties fulfill the contract.
Initial margin is also called Ordinary margin. The deposit of initial margin has to be 50% as the minimum of the stated value of the contract.
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Maintenance Margin
Maintenance margin is the deposit that is kept for the whole duration of the contract. It is the minimum balance that has to be kept as the deposit in the margin account.
The normal maintenance margin is up to 25% of the stated value of the contract. The maintenance margin is usually the 75% of the Initial Margin or 7.5% of the stated value of the contract.
If the deposit in the margin account goes below the minimum required balance due to wrong call by the investor in shares, the investor has to pay the amount to maintain the minimum balance in the Margin account.
Maintenance Margin = Initial Margin x Maintenance margin percent
Variation Margin
Variation margin is the difference that occurs when the amount as deposit falls below the minimum balance in the margin account.
If the investor’s account goes below the minimum balance, he/she has to pay the variation and replenish their account back to the minimum balance.
In simple words, variation margin is the amount that is needed to be added to the margin account to maintain the minimum balance if the investors account ever goes below the minimum balance.
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FAQs
What is meant by margin in trading?
For future contracts in trading, the broker takes up an additional amount of about 5%-10% of the stated value. This additional amount is a security or guarantee for the broker for the risk they bear when the investor borrows from the broker to trade in Market instruments.
Is margin trading a good idea?
If you are a professional, or have a broker for your investments, margin trading can be an excellent idea. But if you don’t have strong market knowledge, you should not invest in margin trading.
Is margin trading interest free?
No. You have to pay interest to the broker or the brokerage firm you borrowed money from. The interest you have to pay fluctuates depending on the market and the broker or the brokerage firm.
Closing Statement
Trading is an amazing way to increase the initial amount a person has by investing it in a growing market. In that, margin trading is an option where the brokerage firms provide funds to people who do not have enough to invest in the market in returns for interest on the capital they lend to the investor.
Margin in trading is the safety deposit for lending the money to the investor in case losses occur, which is beneficial for both parties. This gives opportunities for traders who study the market to trade even if they don’t have enough funds.
I hope this article about What is Margin in Trading is helpful and informative to you. If there are any queries or suggestions, deposit it in the comment box.
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