Trading on margin is a risky business, but can be profitable if managed properly, and more importantly, if a trader does not overleverage themself. It also makes accessing certain asset values easier as a trader doesn’t need to put up the total cost of an asset when they see an interesting trading opportunity. When entering a trade on margin, it’s important to calculate the borrowing cost to determine what the true cost of the trade will be, which will accurately depict the profit or loss.
Calculations
Margin Trading
With Margin trading you can trade on a small amount of money.
Trading on margin allows traders to take advantage of trading opportunities without having to worry about a huge capital investment to acquire an asset.
Margin trading, on the other hand, entails using leverage to raise risk and potential returns. Margin is usually expressed as a percentage of the size of the forex positions and varies per forex broker. In the forex market, a 1% margin is common, meaning that dealers can control $100,000 of currency with just $1,000.
Calculating Margin
The margin for a forex deal is calculated using a simple method. Simply multiply the trade size by the margin %. Then, from the remaining equity in your account, remove the margin utilized for all deals. The resulting figure is the amount of margin you have remaining.
Calculating Margin Example
Example:
Suppose you want to borrow $30,000 to buy a stock that you intend to hold for a period of 10 days where the margin interest rate is 6% annually.
1
To figure out how much it will cost you to borrow money, multiply the amount you want to borrow by the rate you’ll be charged:
$30,000 x .06 (6%) = $1,800
2
Then divide the result by the number of days in a year to get the total. Rather from the expected 365 days, the brokerage sector typically employs 360 days.
$1,800 / 360 = 5
3
Multiply this figure by the total number of days you’ve borrowed or expect to borrow the money on margin:
5 x 10 = $50
In this case, borrowing $30,000 for 10 days will cost you $50 in margin interest.
While margin can be used to increase profits if the price of your investment rises and you make a Leveraged purchase, it can also increase losses if the price of your investment falls, resulting in a margin call, or the need to add more cash to your account to cover those paper losses.
Remember that whether you profit or lose on a trade, you will still owe the same margin interest as the original transaction.
Final Thoughts
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