Margin Trading and Asset Classes

You can use margin to trade most asset classes. For example, you can invest directly in stocks, buy stocks you like and hold them, and sell them at the right time.

The share price proceeds should still be profitable in addition to the repayment of the broker (including interest).

Suppose you want to buy shares of a famous company, the broker may require a 50% margin. This means that if you invest 50,000 pounds, by working with your broker, you can buy 100,000 pounds worth of shares.

If the share price rises by 20%, you will make a profit of 20,000 pounds. In fact, after paying interest and trading fees, the profit is slightly reduced, but this is still good news for an investment of 50,000 pounds.

If the stock market falls, when the stock falls by 20%, you will lose 20,000 pounds directly, plus interest, 50,000 pounds of borrowing and transaction costs. This is the risk of margin trading, and you are also facing the same huge losses while enjoying a good return.

Derivatives

For experienced investors, it is profitable to trade stocks directly on margin, but the principle of margin trading also applies to small investors, such as trading financial instruments: CFDs.

Investors who own shares can trade CFDs to hedge the downside risk of the price of their holdings.

Investors will use CFDs to short. If you predict that the stock price will fall, borrow the stock and sell it at the current price (short the stock market).

If the stock price does fall, you can buy the stock you previously shorted.

CFDs enable investors to short the market at will because they do not have to borrow or own shares.

What is a Contract for Difference (CFD)?

A Contract for Difference (CFD) is a form of trading the price of an underlying asset (e. G., a stock or commodity) with a broker on the basis of a bid-ask spread. The delivery time of the contract is usually agreed.

You don't really own the asset, so you don't have to pay full price or taxes when you sell it. CFD brokers only charge 5% of the asset price for margin. Some brokers will set lower or higher margins for different assets, and in general, it is normal for the amount to be in the range of 2% to 20%.

You can speculate that the price will rise (go higher) or fall (go lower), and the exit point is the trading price at the close of the day. Alternatively, you can also set the price at which you enter and/or exit the market.

If the asset rises or falls more than you expect, you will lose further advantage. But after a price spike, you are protected from a price drop or rebound.

You can choose to hold CFDs for more than one day, but you need to pay additional interest, usually close to or calculated at the interbank peer lending rate. CFDs are tax-efficient because there is no stamp duty. However, some brokers may charge you a transaction fee for opening and settling CFDs.

Hedging

An investor who now holds 1,000 shares of ABC stock and is worried that the price will fall may trade short-term CFDs on the same company.

If the share price falls, the value of the investor's stock will be damaged, but it can be offset by the profit of the CFD transaction (minus the interest on the borrowed funds and other transaction costs).

But investors don't just hedge against stock price movements, you can also use margin to predict the rise and fall of currency pairs, the direction of stock market indices, the rise and fall of commodity prices, etc.

Margin trading is not limited to a single asset class, and the role of margin is to allow you to make greater profits, or potential losses, from trading.

Margin Retail Trader

Retail investors can now use automated systems in online and mobile apps to simplify margin trading, often based on CFDs. You may only need a small amount of capital to start trading, and generally, trades are settled when the exchange is closed.

Trading systems are heavily regulated, usually with leverage caps set by regulators. You may not have a private margin account with a major broker like a large investor, but participating in margin trading is very simple.