Last Updated on September 18, 2023 by BFSLTeam BFSLTeam
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.
Table of Content
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 Trading and Futures Trading
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.
Advantages and Disadvantages: Margin Trading vs. Futures Trading
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.
Margin Trading vs. Futures Trading: Which Suits You Better?
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.
