In financial investment terms, a margin involves the mathematical amount representing the difference between equity (what the investor owns) and used margin. Understanding this value helps an investor decide how much can then be used for new trades and investment positions beyond the investments already made. No one wants to be over-committed, as that can lead to serious problems during price changes. So, the margin level is used as the extent of exposure possible without creating unmanageable risk in a portfolio.
As the margin level rises, the investor has more funds to work with. On the other hand, as the margin level drops, the less there is available for trade and the closer the investor is getting to running out of liquidity. When that occurs, the investor then must pay up for positions taken or pump more liquidity into existing positions.
The technical calculation of a margin level is:
The Margin Level is equal to Equity divided by used margin. That figure result is then multiplied by 100 percent.
Margin Level = Equity / Used Margin x 100%
Ideally, the safe spot is to not get below 100 percent. Anything below is pretty much a signal that one is in the red. Getting close to 100 percent means your investment power is almost tapped out. New positions are a really bad idea at this point. On the other hand, well above 100 percent indicates that your investment power is generally not being used, and you have room to add more to the portfolio to expand your profit capability.
Why does all the above matter? If an investor is just using straight funds to buy, hold and sell positions, it doesn’t matter much at all. The investor knows what’s in the bank and what is committed in his position on the market. He either must sell existing positions to free up liquidity for new purchases, or he must add more external cash to the portfolio for added liquidity. However, if the investor is borrowing against existing positions being used as collateral, margin levels matter a lot.
When an investor borrows against an existing position, he is assuming the existing position will continue to grow in value. This means that if the loan comes due, and the investor must use the existing position to cover the loan, he has plenty of value to do so without going insolvent. In the meantime, the investor can create new positions with the borrowed funds to create new channels for profit and gain. Even if those lose value, if the collateral used maintains value, the loan is covered and repaid. This leveraging of existing assets with financing to gain on new investments is common in the options market as well as arbitrage plays in forex markets. It’s also very risky as things can reverse very quickly. Ergo, the margin level is a key indicator of impending risk relative to value and market price changes.
Disclaimer: All information provided here is intended solely for study purposes related to trading financial markets and does not serve in any way as a specific investment recommendation, business recommendation, investment opportunity, analysis, or similar general recommendation regarding the trading of investment instruments. The content, in its entirety or parts, is the sole opinion of SurgeTrader and is intended for educational purposes only. The historical results and/or track record does not imply that the same progress is replicable and does not guarantee profits or future profitable trading records or any promises whatsoever. Trading in financial markets is a high-risk activity and it is advised not to risk more than one can afford to lose.