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How is Futures Trading Different From Margin Trading?

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The difference between margin trading and futures trading is crucial for investors and novice investors must well-verse themselves with these concepts and the risks and benefits associated with them. Futures trading and margin trading are investment methods that allow investors to capitalise on market movements. 

 

Although both methods involve leveraging, they vary in their mechanisms, assets, and associated risks. A key difference is that margin trading is used for day-trading while futures trading is not. Read on to explore the differences, advantages and disadvantages of these two investment facilities so you make an informed investment decision.

What is Margin Trading?

The future margin trading, or the margin trading, allows you to borrow funds from a brokerage for the purpose of an investment in the stock market. The margin trading helps you amplify your purchasing power so you can buy more shares than you could have afforded with your available capital. Margin trading is only meant for day-trading purposes. 

Also Read: What is Margin Trading Facility – A Detailed Guide

What is Futures Trading?

Futures trading is not a short-term investment strategy as you can hold positions for even up to three months. It is a contract to sell or buy assets, securities, or commodities, at a future date. 

The futures trading agreements are also called futures contracts and are standardised. You need to open a trading account with a brokerage to do futures trading. These contracts are traded on organised exchanges like the Multi Commodity Exchange (MCX).

Unlike margin trading, futures trading does not require borrowing money from a broker. Here an investor or trader agrees to buy a particular quantity of securities, assets, or a commodity, and take the delivery on a predetermined date. The seller accordingly agrees to provide it. If you purchase a futures contract, your assessment is that the price of the asset will rise.  

The participants in the futures markets are mainly commercial or institutional commodities producers, or consumers.

Difference Between Margin Vs Futures Trading

Aspect

Margin Trading

Futures Trading

Ownership of Assets

Traders acquire ownership of the assets purchased using borrowed funds. However, this is not the case in futures trading, where the underlying asset is not owned, and transactions are based on predicting price changes.

Traders do not hold ownership of the underlying asset. Instead, they focus on speculating price fluctuations.

Risk and Leverage

Margin trading carries a higher degree of risk and leverage due to the use of borrowed funds. This enables larger trades with limited capital, though it increases potential losses.

Futures trading also involves leverage, but risks are mitigated by predefined margin requirements and daily settlement adjustments.

Timeframe

Margin trading does not have a predefined timeframe, but positions may need to be closed if a margin call occurs when account balances fall below the required level.

Futures contracts have a fixed expiry date, requiring traders to either close or settle the position before the expiration period ends.

Price Determination

The price is determined based on the current market rate at the time of the trade.

Futures prices are influenced by expectations of market conditions and demand at a future date.

Margin trading is a contrasting trading method as compared to futures trading, though the basic concept of the two is the same. 

It is important for you to understand what differentiates the margin trading from the futures trading as it will help you decide which among the two suits your investment goals and strategies. Here are the key differences:

  • Ownership of Assets: In margin trading, you actually own the assets you purchase using borrowed funds. However, in futures trading, you do not own the underlying assets; you are only speculating on their price movements.
  • Risk and Leverage: Margin trading involves higher risk and leverage compared to futures trading. While both methods allow you to control larger positions with a smaller amount of capital, margin trading’s leverage can be more substantial since it is essentially using borrowed money.
  • Timeframe: In margin trading, there is no specific timeframe for closing your position unless you receive a margin call (when your account balance falls below a certain level). In the case of the futures contracts, an expiry date always exists; meaning that you need to settle the contract before a particular date. You do so either by selling or taking physical delivery of the underlying asset.
  • Price Determination: The pricing of futures contracts is based on estimation. It means that you determine the existing market conditions and make an assessment of the asset’s price in the future. However, in case of the margin trading, the price is decided by the prevailing market price that exists at the time of purchase.

Additional Read: Margin Trading vs Short Selling

Advantages and Disadvantages: Margin Vs Futures Trading

Aspect

Margin Trading

Futures Trading

Pros

Enables higher purchasing power, allowing traders to seize more market opportunities.

Offers reduced risk since investments are not reliant on borrowed money.

Allows traders to maintain positions for longer periods without concerns about contract expiry.

Provides the ability to earn profits in both upward and downward market trends by trading long or short.

Ownership of assets brings additional advantages, such as dividends and voting rights.

Operates in a transparent and regulated trading environment through organised exchanges.

Cons

Leverage increases risks, potentially leading to larger financial losses.

Fixed contract expirations require traders to manage positions actively before the expiry date.

Margin calls can occur if asset values fall below the margin requirement, forcing liquidation.

Demands a comprehensive understanding of markets and underlying assets for successful decision-making.

Losses can create emotional stress, which may influence investment choices negatively.

May result in significant losses if positions are not managed effectively, particularly in highly volatile markets.

Before you decide which of the two investment strategies are suited for your trading goals, it is important that you understand the advantages and disadvantages associated with margin trading and futures trading. So, let’s explore the pros and cons of the two trading methods:

Margin Trading:

Pros

  • You will have more buying power that will let you seize the market opportunities.
  • You have the option to hold positions for an extended duration. You do not have to be worried by contract expirations.
  • Ownership of the assets provides additional benefits like dividends and voting rights.

Cons

  • Higher risk due to leverage, potentially leading to substantial losses.
  • Margin calls can occur if the value of your assets falls below the required margin level, leading to forced selling.
  • Emotionally challenging as losses can impact investors’ decision-making abilities.

Futures Trading:

Pros

  • Lower risk compared to margin trading, as you are not borrowing money to invest.
  • The ability to profit from both rising and falling markets, as you can go long or short on futures contracts.
  • The transparent and regulated trading environment on organised exchanges.

Cons

  • Futures contracts have an expiration date, which means you need to actively manage your positions.
  • Requires a thorough understanding of the market and underlying assets to make informed trading decisions.
  • The potential for unlimited losses in certain situations, especially if you do not manage your positions effectively.

Additional Read: What is Peak Margin

Margin vs Futures Trading: Which Suits You Better?

Factor

Explanation

Risk Tolerance

For those looking for a safer investment method without taking on the risks of borrowing money, futures trading could be a better choice.

Trading Experience

Experienced traders in the stock market might find margin trading more suitable, while futures trading is often a better starting point for beginners due to its structured nature.

Time Commitment

Margin trading provides the flexibility to hold positions for longer periods, whereas futures contracts have fixed expiry dates, requiring regular monitoring and active management.

Market Analysis

Effective futures trading depends on the ability to accurately analyse markets and forecast trends. If you enjoy observing patterns and studying trends, futures trading may be a good match for your skills.

Are you confused between margin trading and futures trading and still thinking which approach of investment suits you the best? The answer is simple. You need to understand your investment experience, trading goals and risk tolerance capabilities.

Here is an explanation of the factors that you need to consider when making this decision:

  • Risk Tolerance: If you don’t want to take a risk and prefer to adopt a secure approach, futures trading may be your proper investment option as it does not involve borrowing money.
  • Trading Experience: If you are experienced in stock market and trading, then margin trading is more suited for you. If you are a novice trader, starting with futures trading might be more suitable.
  • Time Commitment: Margin trading allows for more extended positions, while futures contracts have specific expiration dates. Consider your availability and willingness to actively manage your trades.
  • Market Analysis: Successful futures trading relies on accurate market analysis and forecasting. If you enjoy studying market trends and patterns, futures trading may align better with your interests.

Also Read: Difference Between Margin Trading And Leverage Trading

Conclusion

Margin trading and futures trading offer distinct approaches to investing in the Indian financial markets. While margin trading offers higher potential for profits but also exposes you to higher potential for losses, futures trading is more stable in results. The difference between margin trading and futures trading lies in the ownership of assets, risk and leverage, timeframe, and price determination. 

In case you are new to shares and the financial market, it is important that you calculate your risks meticulously and be genuine and unbiased about your assessments. While margin trading and futures trading allow increased profits, it is important to understand that your calculations and assumptions are to be based on trends and experience.

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Frequently Asked Questions

What is margin in futures trading, and how does it work?

Answer Field

What is margin in futures trading refers to the initial deposit traders must provide to open positions. This ensures potential losses are covered in highly leveraged markets, protecting both traders and counterparties. Margins are essential for maintaining risk accountability.

What are the risks associated with margin trading?

Answer Field

The risks of margin trading include significant losses due to leverage, margin calls, and forced liquidation when asset values drop. Borrowing costs and emotional stress can compound issues, especially compared to futures vs margin scenarios where risk mechanisms differ.

How much margin is required to trade in futures contracts?

Answer Field

What is margin in futures trading depends on factors like contract size and volatility. Typically, initial margins are necessary, alongside daily maintenance margins that adjust with price changes. This framework supports risk management in futures markets.

Can I lose more money than my initial investment in margin and futures trading?

Answer Field

Yes, in both margin vs futures contexts, leverage amplifies losses. Adverse price movements can result in debts exceeding your initial investment, making risk management essential in futures vs margin scenarios where losses may surpass expectations.

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