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Amplifying Gains from Limited Capital; Understanding Margin Trading in a nutshell

In very simple terms, Margin Trading refers to the practice of trading assets using funds provided by someone else a.k.a. third party. The margin is the collateral that an investor has to deposit with their exchange, or broker, to cover the credit risk the holder poses for the exchange/broker.

Margin trading accounts allow traders an access to greater sums of capital, compared to regular or spot trading accounts — thus allowing them to leverage their trading positions.

In many ways, margin trading provides amplified trading results by realizing bigger profits — or losses — for traders.

Margin trading is a facility under which traders can buy assets that they cannot afford. The trader is allowed to buy assets by paying a marginal amount of the actual value. The rest of the margin is usually paid in assets deposited by the trader as security or collateral.

A trader commits a percentage of the total trade value to open a margin position.

The extra amount to complete the trade is usually provided by an intermediary / broker who funds the margin trading transactions. This is generally a short-term loan provided for the type of leverage available in the market, or the trade being executed at that point in time on a particular asset.

The margin can be settled after the duration of the trade is over when the trader squares-off his position. The trader will either make a profit or a loss based on how the trade parameter goes on the exchange.

Please note, the trade can be either way — profit or loss.

A diagrammatic depiction of 50 to 1 leverage
A diagrammatic depiction of 10 to 1 leverage

What does one need?

Margin refers to the amount of assets an investor has in their brokerage account.

A Margin Trading Account on an Exchange

  • Marginable assets in their account that can be used as collateral.
  • Liquidity provider who provides the loan to create the margin

An Example

  • Let’s say that you deposit $10,000 worth of assets in your margin account that allows you a 50% initial margin.
  • This means you have the purchasing power of $20,000 worth of assets.
  • So, if you end up buying $5,000 worth of assets with this power, you will still have $15,000 in buying power remaining.
  • This means, you have enough cash to cover this transaction and still haven’t tapped your full margin availability.
  • You will only start borrowing only when you buy assets worth more than $10,000.

Note: Buying power of a margin account will change depending on the price movement of the marginable assets in your margin account

Risk, Advantages, and Key Takeaways of Margin Trading

The user needs to consider the fact that borrowing money comes with costs. The primary cost comes as an interest that one has to pay on the loan taken. The interest charges are applied to the account until payments are cleared. It is to be understood that the marginable assets in the account are considered as collaterals.

Advantages and Disadvantages of Margin trading

Important Terms to remember

Maintenance Margin — Minimum amount of assets in value that you must maintain in the margin account after a purchase has been made.

Margin Call — A demand from your brokerage for you to add money to your account or close out positions to bring your account back to the required level.

Minimum Margin — initial amount the investors are required to deposit into a margin account before starting to trade on margin — long or short.

Initial Margin — percentage of the purchase price of an asset that must be covered by collateral when using a margin account.

Key Takeaways

About EasyFi

EasyFi Network is a universal layer-2 multi-chain money market protocol for digital assets with focus on liquidity sourcing & capital efficiency for structured lending in a non-custodial manner. The Protocol is currently live on Polygon, Binance Smart Chain and Ethereum.

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To learn more about $EZ and EasyFi, please go through our whitepaper and other articles on this publication. Stay tuned for more news & updates on our Telegram channel and join the official group. You can also follow us on Twitter.

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EasyFi Network

EasyFi Network

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EasyFi is a Layer 2 DeFi Lending Protocol for Digital Assets. Focused on plugging various gaps in DeFi adoption, powered by the efficient Layer 2 Blockchains