What is Margin Trading ?
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- What is Margin Trading ?
In the interbank trading a similar kind of business volume counts millions of dollars. Hence, it’s not accidental that such level is not available to private investors and the majority of people.
At present there is an opportunity for small and medium investors to have access in Forex due to the respective brokerage companies. People from various parts of the world enter the foreign exchange market with approximately 1,000-2,000 dollars. Clients are provided with a credit line, which is known as “Dealing lever” or “Leverage”, and sometimes with the deposited sum. Broker demands deposit which is a security sum and which makes it possible for the client to buy and sell money 50.100, and from time to time 500 times greater than the deposit made. It’s risky for the client to have losses, whereas deposit has a collateral function of insuring the broker. In the company this kind of work system that makes use of leverage provided is called “Margin Trading”.
To put it in other words, Margin Trading is realized through the following scheme: the investor puts a margin capital as a reciprocation of the opportunity to operate a targeted credit which is safe in the deposited margin capital. He conceals losses which are likely to occur after the currency exchange transactions.
On the other hand, as compared with currency exchange transactions which main purport is the actual delivery or exchange of currencies, Forex participants, particularly the ones whose funds are relatively small are included in trading on a security collateral. This kind of trading is known as “margin” or “leveraged trading”. Each of the margin trading operations is realized by two steps: sale of a currency at a present exchange rate and a subsequent sale of one and the same amount of currency at different or the equable price. The former is accepted as a position opening while the latter as a position closing. In the case of opening a currency exchange position there is a lack of real currency delivery, however, a part of the trader’s security deposit continues to be accepted as a warrant on probable losses that may arise because of the position opening.
In such cases when there is a possible growing potential of the value of the Euro against the US dollar, a capitalization on a presumable rate increase would be a purchase of Euro for US dollars with a subsequent sale at a higher value when the EURUSD exchange has come forward. According to the conditions of Forex trading this can be realized by opening a position, i.e. buying Euro, and closing a position, i.e. selling Euro. The position which is still closed is accepted to call a long EURUSD position. Just in the same way the inverse actions are likely to be considered when the currency’s future provision informs us about a probable weakening of the currency against another one. In similar circumstances we should open a short position and close it in the case of the exchange rate falling. In other words, we should sell the currency and later purchase it back.
It’s possible for retail clients to establish contact with Forex market by an intermediate person, Forex broker, who is responsible for a sound communication channel and a consistent broadcast of real market quotes, as well as for a direct interaction in the communication process. The latter not only ensures the processing of the trading account administration tasks but also gives responses to the trader’s trading orders.
Due to this kind of online services, a trader has an opportunity to operate a trading account without being forced to be physically present. A trading station is provided with the fully functional devices with such an Internet connection like PC and PDA, as well as mobile phone which provides Forex trading with a wider unprecedented audience.
The agreement between a client and a company comes to the conclusion as a result of which the company should realize operations on behalf of the client and at its own expenses. However there is a danger for the company to have losses during these operations. This is because the client who gives orders may not be right in his presuppositions connected to the market movement, whether the latter is upwards or downwards. Nevertheless, to overcome such problems the client should deposit certain sum of money into his account in a bank as a margin capital. The Margin capital amount is determined according to the sum of transactions that are made by the bank and by credit leverage as provided to the client. If performed operations bring losses to the Brokerage Company, the investor is responsible for the financial obligations to the Company.
In case of loss incurred by the Brokerage company as a result of performed operation, investor has financial obligations to the Company at the amount of loss that is covered by the security deposit; in case of profit made by the Company as a result of performed operation, the Company incurs obligations to the investor at the amount of this profit. Received profit is deposited into clients security account.
It’s necessary to close an open position if required by the client, since the Company makes use of its own funds. If not so, the Bank can replace long position by a short one which may bring losses to the client. Very rarely there may occur situations that in the World market currency rates may undergo changes more than by 2% a day, so it’s hardly possible to lose all the margin capital. When it becomes evident for the Bank dealer that potential losses at adverse market movement are likely to surpass the security deposit, he may close clients’ position with loss that does not pass margin amount.
Due to its availability trading on Margin is of great significance. It’s doubtless that the bonds of the U.S. Federal Reserve are the most constant and reliable, and though their cost is high they do not provide a high profitability (in the range of 3-6% per annum) and they serve as subject of reliable and long-term investments. Though the profitability on the stocks is higher, the sum of dividends has direct connection with the preferences and potentials of the partners and the success of the company. A practical knowledge and experience are of utmost importance in buying stocks on order to speculation for a rise which itself is quite interesting. There is no above limitation in Margin trading and 1-3% of transaction amount is considered to be enough for operating.