What trading method is the right fit for you?
A trading method is necessary for obtaining recurring earnings in the financial market. There are a lot of things that we must consider when we operate, and one of them is what we call the method. Knowing the difference between spot and margin trading is crucial for investors to identify opportunities. In this article, we will describe them and help you choose the one that fits your needs.
Spot and Margin trading definition
Spot trading is the action of purchase or selling an asset to take delivery immediately. Examples of these assets are stocks, bonds, commodities, or cryptocurrencies. Although it depends on the type of asset, most of them exchange instantly (“on the spot”) or usually between “T+2 days”.
There are two main viable ways of spot trading. One is in an exchange market like NYSE/NASDAQ in the US. The second option is OTC markets, where buyers and sellers agree on a specific price. This means that the market is unregulated. With the rise of cryptocurrencies, we can trade in decentralized exchanges. These are platforms controlled by smart contracts.
The actual price is called “spot price” and changes in real-time. Yet, in the OTC market, buyers and sellers set the price as they want.
In spot trading, you are executing a trade at the available asking and bidding price offered by market participants. This method is the most common way people trade, especially for beginners, since the operation is straightforward. They can own short-term positions with low spreads and without expiration dates.
On the other hand, margin trading allows investors to borrow funds from third parties for a particular interest rate. So, traders can leverage their position using substantial sums of capital. In this scenario, investors may get significant profits or amplify their losses.
In margin trading, an investor engages a percentage of the total order value as collateral. This initial investment is called “margin” and all securities like stocks, bonds, and cash act as collateral. When a margin call occurs, the trader has to add more funds to keep that position open. Worst-case scenario, the broker could liquidate the position and keep the collateral. These requirements vary from broker to broker.
Advantages and Disadvantages of these methods
| Method | Advantages | Disadvantages |
| Spot trading | Rules, rewards, and risks are simple to understand. You cannot receive a margin call or get your position liquidated. You can enter or exit a trade whenever you want without losing more money than you have in your account. Transparency on prices depends on the bid and ask that the investors are asking for. Low entry barriers. Although other markets are open, this market stands out for the ease of participating. That is why is suitable for starters. | Potential earnings are low since investors are limited to the balance in their accounts. They cannot take full advantage of excellent trading opportunities. Some instruments require further knowledge to operate, such as commodities (e.g., oil, gold, soy) It has high volatility since prices change constantly. So, for a company is not convenient to trade in this market because they cannot hedge against market fluctuations. |
| Margin trading | Opportunity for investors to realize higher returns (or losses) due to leverage. Diversification, although this will depend on the strategy. Opening several small positions may give the trader a higher probability of earning money. | The potential risk is higher because an investor can lose more money than its initial investment. The possibility of being liquidated. It can happen for many reasons, though. If you use too much leverage, small market movements can affect your position. Either by giving you greater profits or substantial losses. Another scenario can be that you have a position open for a long time. Since you need to pay a daily interest, you could run out of funds forcing a liquidation. |
Last but not least, what you choose as your strategy comes down to your trading profile. Every person has a different psychology, risk tolerance, and trading skills, so you need to decide which one fits you the most.
