Trading on margin is a powerful tool that allows traders to increase their market exposure by borrowing funds. However, it’s essential to understand how it works and the risks involved.
This article will break down margin trading in simple terms, using an example of buying NVIDIA (NVDA) stock where the margin requirement is 10%.
What is Margin?
Margin is the money that a trader must deposit to open and maintain a leveraged trading position. Essentially, it acts as collateral to cover potential losses. The rest of the position’s value is borrowed from the broker (Tradeway).
Margin trading amplifies both potential gains and losses. As a result, while it can be a valuable strategy, it’s not without risk.
Key Terms to Know
Margin Requirement: The percentage of the position's value that you must deposit to open the trade. For example, a 10% margin requirement means you need to provide 10% of the total trade value.
Leverage: The ratio of the position’s value to the margin. A 10% margin equates to 10x leverage, as you control 10 times the amount of your margin deposit.
Margin Call: A demand from your broker to deposit more funds to maintain your position if your losses approach your deposited margin.
Example: Buying NVIDIA (NVDA) Stock with 10% Margin
Let’s say NVDA is trading at $140 per share, and you want to buy 10 shares. Here’s how it works:
Notional Value
$140 (price per share) × 10 (shares) = $1,400
Margin Requirement:
With a 10% margin requirement, you need to deposit:
$1,400 × 10% = $140
Leverage:
You are effectively controlling a $1,400 position with just $140, giving you a leverage of 10:1.
Borrowed Amount:
The remaining $1,260 is borrowed from Tradeway.
How Profit and Loss Are Calculated
When trading on margin, your profit or loss is calculated based on the total position size, not just your margin deposit. Let’s examine two scenarios:
Scenario 1: NVDA Rises to $160
Position Value:
$160 (new price per share) × 10 (shares) = $1,600
Profit:
$1,600 (new value) - $1,400 (initial value) = $200
Scenario 2: NVDA Falls to $120
Position Value:
$120 (new price per share) × 10 (shares) = $1,200
Loss:
$1,400 (initial value) - $1,200 (new value) = $200
Risk Management
Trading on margin can magnify losses as well as gains. To manage risk:
Use Stop-Loss Orders: Set a predefined price to automatically close your position and limit losses.
Monitor Margin Levels: Ensure you have enough funds to avoid a margin call.
Diversify: Avoid putting all your capital into a single trade.