Welcome to the Investors Trading Academy talking glossary of financial terms and events.
Our word of the day is "MARGIN" Margin is a deposit that is used as collateral
when entering a financial transaction. The trader makes this deposit in 'good faith'
to purchase or sell a contract of a currency or commodity. It is the same thing as leverage
but the only difference is that margin is characterized in percentage and leverage is
shown as a ratio. Basically you are borrowing money to purchase
securities, similarly to a down payment on a car, but you are not taking physical delivery
so the asset is held as collateral. Your down payment or equity is a percentage of the value
of the security held in a margin account. When an investor uses a margin account, he
or she is essentially borrowing to increase the possible return on investment. Most often,
investors use margin accounts when they want to invest in equities by using the leverage
of borrowed money to control a larger position than the amount they'd otherwise be able to
control with their own invested capital. These margin accounts are operated by the investor's
broker and are settled daily in cash. But margin accounts are not limited to equities
- they are also used by currency traders in the forex market.
In other words, margin is a courtesy deposit needed to access a leveraging facility in
forex. Your deposit is also known as an initial margin or initial deposit. Say, you have $100
in your account and your leverage is 100:1. This means that you can trade up to $100,000
worth of currencies. Your account balance will be 'earmarked' and
locked for every transaction that you make leading up to the $100,000 mark. So if you
hold a $10,000 open position, $100 of your account balance is tied up as a security to
your broker. Buying with borrowed money can be extremely
risky because both gains and losses are amplified. That is, while the potential for greater profit
exists, this comes at a hefty price - the potential for greater losses. Margin also
subjects the investor to a number of unique risks such as interest payments for use of
the borrowed money.