There comes a point in every successful trader’s career when they graduate into margin trading. Once you have a solid foundation of knowledge and experience in trading your preferred asset classes, you will start developing the confidence to make strong predictions about upcoming price movements. With this growing confidence comes the awareness that you could be making even greater absolute returns on each correct call that you make.
Margin trading allows you to make trades while depositing only a fraction of the total amount of the trade. This “trading on margin” means that you can have a total amount invested at any one time that is greater than the total value of your trading account. The more that you have invested, the greater your potential returns relative to your account size.
However, this also means that you have an equally greater potential to lose money on failed trades. Many equity traders borrow around half again the value of each trade, so that their gains and losses are multiplied by 150%.
On the other hand, some currency traders place trades with 20 times the value of their borrowed funds relative to their deposit. Obviously if trades like these go very wrong, the trader can lose more than the total value of their account.
This is why it is critical that traders who are new to margin trading follow these 4 essential tips.
Know The Rules
While margin trading is in essence just as simple as it sounds, there are a number of rules for each broker that can make or break a successful margin trading strategy.
Whether it is the rates of interest for borrowed funds, the procedure for covering margin calls or the wide variety of margin limits for different asset classes and trades, it is important that you have a detailed and comprehensive understanding of your broker’s margin trading rules.
When you first start margin trading, treat it like a first credit card. The enormous potential for out-sized returns can draw inexperienced traders into potentially catastrophic trades.
Take some time to practice with low levels of leverage to get a feel for the new trading dynamic that margin trades bring. Once you are successful and comfortable with a smaller level of margin borrowing, then graduate to a higher level by increasing your size that you are trading at.
Every trader knows to fear the sudden and unexpected price movements that can quickly turn a good trade bad. Whether it is a major player opening or closing a position or a sudden relevant news flash, it is next to impossible to predict these sudden price changes.
While these sudden price movements can be frustrating enough for all traders, they are especially dangerous when you are trading on margin. Sudden price shifts will be multiplied by the amount that you have borrowed, so you want to be sure that you do not let your position decline past a certain point. Use stop orders to ensure that you set a lower bound on your losses for each margin trade.
Monitor Your Positions
When you are used to trading without a margin, particularly in the case of vanilla equities and bonds, it is not unusual to “ride out” a bad turn in a trade in the hopes that it will turn back around. With margin trading, a bad turn can quickly grow into an account-crushing catastrophe.
Do not lose track of your margin trades, as they can turn bad at a much faster rate than normal trades. Learn to closely monitor your margin trades and cut your losses before they can do serious harm to your account’s value.