In time past, retail traders could not trade currency pairs on the forex market, it was the exclusive preserve of banks and other big financial companies.
But with the introduction of margin and leveraging, retail traders with small accounts can now take trades and earn profits.
Margin allows traders to place trades with bigger position sizes than their account balance would have been able to.
In real terms, the margin is not leveraging on its own, but it can be used as a form of leverage because the amount of money you have in your trading account will determine the leverage you would use to open bigger trading positions.
While its margin can help traders to open bigger trading positions, buying and selling of currencies can be a two-edged sword.
This is because one can make enormous profits and sometimes losses.
For traders who have low capital, margin trading can sometimes give profits while at times it may lead to excruciating losses and most undesirably; a margin call.
What is Margin?
Margin is simply the deposit/money in a forex account used to open a trading position and used to keep it open.
Margin trading allows traders to control a larger position size than the initial trading balance would allow.
It involves your broker lending you a bigger percentage of your equity so that as to earn more profit on the forex market.
Pitfalls of Margin Trading on Low Capital
Applying margin to trades especially on an excessive level could be catastrophic if your capital is not substantial to handle exposures.
Let’s see more pitfalls about margin trading…
Overleveraging is simply taking up more leverage than your trading balance will allow.
Engaging in overleveraging on your margin account can lead to serious consequences on your trading balance, as it is an all-or-nothing approach that could wipe your account, even with the most minute of corrections in price.
• Not Thinking Long-Term
Thinking long-term for a trader who has low capital is very important.
A trader who does not think long-term will eventually find himself having many small wins that do not boost his capital in the long term.
• Opening Too Many Positions
While it is true that margin trading allows you to open more positions than the size of your trading account.
To be a successful trader, you have to ensure you do not overuse it. Opening too many positions at once causes your available margin to deplete thereby reducing your trading capital.
If you want to trade a small account successfully, risk a little amount of your capital per trade.
• Not Using Stop-Loss Orders
Stop-loss orders are useful for closing trades and minimizing losses. Not using stop loss is more or less a recipe for disaster.
For example, in a situation whereby a trade goes against your bias, stop-loss orders are useful for automatically closing your position-even when you are not available to close your open position(s) yourself.
• Risk To Reward Ratio
The risk to reward ratio is the ratio of your potential losses to your potential profits.
For better results in boosting your trading account with margin, using a risk to reward ratio of less than 1 is the most ideal.
For example, if you are willing to risk $100 on trade to earn $200, the risk to reward ratio will be 1:2 which amounts to 0.5.
This means that you may have two losing trades and one winning trade and still break even.
• Undercapitalized and Overleveraged
You can get liquidated without your permission. While trading, the equity in a trader’s account has to maintain a value known as the maintenance margin.
If the trading account is holding too many losing positions such that the maintenance margin is not maintained, the broker will issue a margin call for you to either deposit more funds, close some or all of your existing positions OR your account will get liquidated.
Consequences of Margin Trading on Low Capital
1. Potential losses
Margin trading increases the possibility of losses for a trader. While losses depend on the amount of leverage a trader uses, a little price change can have a giant negative effect on equity.
This is why traders must use the proper risk management and risk mitigation tools such as stop-loss orders, and trailing stops to protect profits.
2. The rewards might not be worth it
One of the main disadvantages of trading forex is that there are many losses and a few profits along the way that may not be worth your time
3. Inability to trade with flexibility
A trader with low capital using margin will find it difficult to cope with major pullbacks for trades that will eventually become profitable.
Let us take an example, If MR. A buys the currency pair EUR/USD on an account with a margin of 1% with an account balance of $1000.
If the trade encounters a pullback to 0.336 he would have lost the sum of $990 which might make him want to close his opened position so that he will not be margin called, whereas the trade would have turned around in his direction of bias a few pips later!
• Over leveraging
• Higher leverages increase market movement that goes against trade direction
Margin trading is a useful tool for traders looking to amplify their profits and boost their trading capital.
In fact, With the opportunity that leverage provides through margin accounts, profits and losses can be amplified by little changes in market prices.
Therefore, it is advised that traders who would use margin accounts understand the use of margin thoroughly before venturing into trading.
It is also important to make use of risk-mitigating tools like stop-loss to protect your account from significant losses.
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