Margin in Trading, definition, risks and alternatives
Published: November 24, 2020 by Andrew
Margin is the practice of buying stocks or any other financial security using borrowed money.
The advantages of this technique are many and we will see them in detail in brief, even with an example. However, there are also quite high risks that must be considered.
There are novice investors who have literally ruined themselves by margin and other experts who have built real fortunes with this system.
In this guide we also explain which is the most recommended leverage system for beginners who want to start without mistakes (and don’t want to screw up).
For this we will talk about some of the best online trading platforms, including the famous eToro. Why do we mention it right away? Because it is the only platform that even allows you to copy, in a completely automatic way, what the best traders in the world do.You can sign up for free on eToro by clicking here
What is Margin, explained with an example
To better understand the concept of Margin, we will start with an example. We want to buy Amazon shares for € 10,000 but we have only € 1,000 available.
We can buy on margin and apply for a loan of 9,000 euros to our broker. Obviously on this price we will pay an interest (usually high) but the practice is still apparently convenient.
Let’s suppose that Amazon’s shares increase by 10%: when we close the deal we find ourselves a profit of 1,000 euros (10% of 10,000). Taking into account that our starting capital was just € 1,000, we made an actual profit of 100%. To be precise, the profit will be slightly lower because there is interest to be paid, but in this case they are negligible compared to the profit obtained.
It is important to note that if there had been no margin, the profit would have been just 100 euros. We earned 900 euros more, not bad.
Is margin therefore a tool that allows you to multiply your earnings? Yes, true, you can earn a lot more but there are also much higher risks.
Let’s continue with our example to understand what the risks of margin are. Let’s say Amazon’s stock plummeted by 10%. It happens, playing the stock market involves risks and no one, not even the best, can make 100% sure predictions in all cases.
What happens in this case? Those who operated without the margin lost only 100 euros. Those who operated with margins, on the other hand, lost 10% of € 10,000, or € 1,000.
In practice, it completely burned out the starting capital. And what would have happened if the drop was 20%? Not only would he have lost all the capital, but he would have found himself indebted to the broker for 1,000 euros.
So margin is a mechanism that can quickly get out of hand to those who are not experts. The fact is that it is debt, real debt, which must be repaid. It’s not a game.
Some examples of the consequences of a light-hearted use of marginalization? Years ago an Italian trader brought Fineco to trial (and lost) accusing it of literally making him lose his house with margin operations.
The judge agreed with Fineco: the man had gone into debt to trade (this is the margin) and having lost everything, he certainly could not blame Fineco for his mistakes: the broker was in his right by claiming to take away the trader’s house who was not paying his debts.
Even more tragic is the example of a very young American who committed suicide in June 2020 after accumulating a record loss of $ 730,000 (which he obviously did not have) with the broker Robinhood.
In his farewell note, the young man accused Robinhood of having induced him to carry out very risky operations.
How to avoid margin risks
Is it possible to defend against these risks? There is a perfect system and that is to completely avoid this technique unless you are really experienced.
Only trading professionals should buy on margin: they know what they are doing because they know the risks and manage them appropriately.
Warning: some might think that it is enough to set the Stop Loss to defend against the risks of margin. This is true but only in some cases.
If you are buying shares, for example, with a margin transaction, and the stop loss is triggered, the platform automatically creates a sell order. But if there is no one who buys (and during panic selling it is a rather typical situation) the shares cannot be sold and the unwary trader’s losses are bound to increase, to the point of ruining him.
How can a novice trader get leverage that doesn’t involve as high of risk as we have seen so far?
After all, leverage is an advantage, because it allows you to multiply your profits but no one should risk losing their home for online trading.
Leverage and CFD
The solution? CFD trading platforms.
CFDs are fairly simple financial instruments to understand: their price is always the same as that of another asset, called the underlying. To understand, the CFD on Amazon shares always has the same price as Amazon shares. It is possible to buy the CFD to bet up or sell it short to bet down.
The profit of an operation is equal to the difference between the price between opening and closing. This profit can be further multiplied by leverage.
What are the advantages of CFD leverage over margin?
- You can NEVER lose more than the capital deposited on the trading account (usually 250 euros)
- In 99% of cases, the platform automatically closes an operation when the overall loss exceeds the amount of the single operation.
- Stop losses always trigger: the platform is in fact a market maker and therefore the order does not need buyers to be executed.
- Supervisors monitor CFD platforms very closely and impose rules for the protection of traders.
- The maximum value of the leverage was reduced by a provision of the ESMA (European Authority for Financial Instruments and Markets) precisely to protect small traders. Those who want to operate with high leverage can still apply for the qualification of professional trader.
Indeed, CFDs have established themselves as the main tool for private traders precisely because of the advantages they offer. In addition to those we have just listed, for example, we can include the absence of trading commissions.
Best CFD Trading platforms
Min. Deposit: 50€
Min. Deposit: 100€
Min. Deposit: 10€
Min. Deposit: 250€
Min. Deposit: 100€
Min. Deposit: 250€
Above, a list of the best CFD trading platforms. We have carefully selected the best platforms, commission-free and easy to use, therefore also suitable for beginners. The minimum capital to start with is around 250 euros.
eToro is one of the most used CFD platforms in Europe, with tens of millions of users. Its success is explained by the fact that it is very easy to use, even for a beginner, it provides excellent teaching material (Trading Academy) and is completely free.
However, there is a single advantage that is worth more than all the others: eToro is the only trading platform that allows you to copy, in a completely automatic way, what other traders are doing.
How? Thanks to the patented Copytrader software that allows eToro users to find professional traders who in the past have obtained the maximum profit with the minimum risk.
The user can indicate to the software which trader he wants to copy and the software will, in a completely automatic way, take care of replicating all operations in real time.
The advantage for a beginner using eToro is twofold: he immediately obtains the same results as a true professional and can also learn how to trade online by observing live what the best traders do.
Indeed, it can interact with them since eToro also works as a social network, it is considered the largest social network of investors and traders in the world.You can sign up for free on eToro by clicking here
ForexTB is the other great alternative for those who want to start trading CFDs without making mistakes.
The platform is completely free and is very simple to use. Even a beginner who has never traded before can orient himself intuitively.
All users are guided on the phone, literally step by step, by a true trading expert. The advice of this expert is truly valuable and can change the life of the trader who has the intelligence to follow them.
Coaching services of this type have a cost on the market of several hundred euros per hour and often those who offer them, perhaps advertising on Facebook, are a charlatan.
ForexTB offers the assistance of a true expert and does it for free: you don’t even have to spend on the phone call, since they call you.
Again, for those who want to learn online trading in depth, there is the possibility to download an excellent course, truly the best among those available today.
The course is free, easy to study even for a beginner, very complete and practice oriented.You can download the ForexTB course for free by clicking here
The advantages of ForexTB are still many, including a very reliable trading signals service for subscribers and an unlimited, free and unconstrained demo.You can sign up for free on ForexTB by clicking here
Margin is a practice that allows you to obtain much higher trading profits but presents significant risks.
In theory, it is a tool suitable only for true experts, professional traders with very high capital and in-depth knowledge of very advanced trading and risk hedging techniques.
Those who have used margin inappropriately have suffered devastating losses: there are also people who have seen their homes taken away for the losses accumulated with this technique.
A tool much more affordable for small traders is represented by CFDs. We explained in the article why they are cheaper and how they mitigate the risk.
We’ve also featured some of the best CFD platforms, including eToro which allows you to automatically copy what the best traders in the world do.
A technique that allows you to buy shares by borrowing money from the broker.
The potential profits are higher but the risks increase exponentially.
Only truly experienced traders with very large capital.
Probably eToro which allows, among other things, to automatically copy what the best professional traders do.