Since there are many methods and many investment options in the stock market, it is bound to confuse anyone who is only stepping foot into the trading world.
New traders often face confusion between a margin trade and futures. So, to help you clear this confusion, here is a look at both these strategies and what might resonate with you the best.
Understanding Margin Trading
Under margin trading, traders can borrow funds from a brokerage to invest in securities that they cannot usually afford with the capital they already have.
By borrowing more funds, traders can increase their buying power and invest in more shares than they can afford on their own. When trading on margin, you can only participate in day trading.
Understanding Future Trading
The very first thing you need to understand about future trading is that it is not a short-term trading strategy as traders can hold their positions for up to three months.
The future trading strategy allows traders to buy or sell securities at a predefined date at a fixed price. The agreements that traders sign in future trading are called futures contracts and you need to open a trading account to carry out these trades. You do not need to borrow funds to participate in futures trading.
Pros and Cons of Margin Trading and Futures Trading
Both margin trading and futures trading, like any trading strategy, have their advantages and disadvantages. Here is a list of the pros and cons of both these trading strategies.
Margin Trading
Pros
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Greater buying power helps gain access to better market opportunities.
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Positions can be held for an extended time.
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Sometimes asset ownership comes with benefits like dividends and voting rights.
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Higher profit potential due to leverage.
Cons
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With greater profit potential, there is also a greater risk of losses because of leverage.
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Margin calls can lead to depositing excess funds in the margin account.
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If the margin amount is not maintained, stockbrokers can liquidate securities to pay back the entirety of the loan taken by the trader.
Futures Trading
Pros
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Less risky than margin trading since there is no borrowing of funds involved.
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Traders can go long or short on futures contracts and profit from both rising and falling markets.
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Futures trading has more regulated and transparent exchanges to trade through.
Cons
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Future contract expiration date leads to constant management of a trader’s positions.
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To make informed decisions in futures contracts, traders need to thoroughly understand how the market works.
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Future contracts can come with unlimited losses in some cases especially if traders are not able to actively manage their positions.
Which Strategy is Better For You
When you are looking to choose between margin trading and trading in futures, here are a few factors that you need to consider when making the decision:
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Risk Tolerance:
If your risk tolerance is low, futures trading may be a better option for you as it does not involve any borrowed amount from a stockbroker.
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Trading Experience:
For experienced traders, margin trading might be a better option while for traders who are new to the stock market, futures trading would be better.
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Time Available:
With margin trading, you have the provision of holding onto positions for longer while in futures contracts there is a specific expiration date that needs to be adhered to.
Conclusion
Both margin trading and futures trading are great strategies if traders know how to use them to their advantage. However, before zeroing in on a specific trading strategy, it is important to explore all of its pros and cons and make an informed decision after.