What is a trading margin
Margin trading is a stock-exchange deal execution using an agent's borrowed funds.
Margin is usually expressed as a percent indicating what part of the cost of a financial instrument is necessary toput down for its purchase (sale).
Margin marketing gives an opportunity to market on price cut of a financial instrument opening so called “short positions”.
Short position is opened by a dealer-in-goods when he waits for price cut of a marketing financial instrument. A mechanism of short sale is following (through the example of stocks):
- Dealer-in-goods takes a definite number of agent's stocks on credit and sells it at current stock exchange price;
- When the stocks' price is expected to cut, dealer-in-goods redeems the same number of shares at a lower price;
- Dealer-in-goods gives the taken stocks back to agent, and takes in his hands remaining money (it is his well-earned profit).
So, the more stocks' price cuts, the cheaper stocks become, and the more profitable will be dealer-in-goods' marketing account.
Margin marketing is also often called a use level of leverage marketing.
For example, level of leverage equal 1:2 (1 to 2), gives dealer-in-goods an opportunity to open positions at a sum twice as much his own means amount. So, level of leverage equal1:2 corresponds to 50% margin.
Level of leverage function
When open position loss «eats»all dealer-in-goods' money, agent involuntary closes this position to have time to take his money back. Such an involuntary position closing is called stop out.
When margin-call is laid down
But before a stop out position closing, agent tells dealer-in-goods about his intention, laying his demands down - margin call. Margin call gives dealer-in-goods a chance to deposit his account to escape the position closing.
To give dealer-in-goods a definite time period for replenishment and for his own funds' security, agent lays margin-call down at the moment dealer-in-goods' money reaching a definite limit value.
Advantages of margin marketing for dealer-in-goods and agent
Thanks to margin using, dealer-in-goods can open big amount positions than his own funds let him. And it, in its turn, means also a bigger potential profit for him.
Moreover, thanks to margin using, dealers-in-goods have an opportunity to speculate not only in prices' increase, but also in their decrease (with the help of short positions opening described above).
Agents, naturally, also benefit by margin marketing. Firstly, arrangement of such credits is beneficial because it s interest is considerably superior to bank's, and it is more beneficial for agent to invest in dealers-in-goods' financing than, for example, to keep it in bank deposit.
Margin marketing considerably reduces barrier to market entry for dealers-in-goods. And it, in its turn, means a sensible increase in new customers (new dealers-in-goods).
Risks for dealers-in-goods
The more agent's margin amount, the higher dealer-in-goods' risk. It is connected with the fact that the higher ratio of borrowed funds to dealer-in-goods' own funds, the higher will be a cost of every price move point for him.