Margin Trading Basics

Definition of Margin Trading

Margin trading is when you borrow additional funds from your broker for trading. Each broker has their own margin trading requirements which is dependent upon a number of factors, such as the volatility of the stock, account size, etc. In order to trade on margin, you will need an approved margin account.

Requirements for a Margin Account

In order to create a margin account, you will need a minimum deposit between $2,000 and $5,000. This deposit is used as collateral against your trading activities. There will also be some sort of application you will have to complete, in order to have your account elevated from a cash account to a margin enabled account. Once an account has been approved, you will only need 50% of the cash on hand to purchase or sell short a stock. For example, if you wanted to purchase $10,000 worth of stock, you will only need $5,000. The one caveat to this, is that for some volatile stocks, there are strict margin requirements. There are some stocks that will require you have up to 80% of cash required to hold the position.

Maintenance Margin

For each stock you trade, there will be a minimum cash balance required to hold the position. This maintenance margin is calculated real-time and brokers will require that you keep the minimum cash on hand to maintain the positions, or (1) you will have to liquidate all or part of your position, or (2) deposit more cash. If you are on the wrong side of the trade, this can become a slippery slope as you will quickly find yourself depositing funds quite frequently.

Margin Calls

My rule regarding margin calls is not to answer them, meaning, do not fund the account to get it above the maintenance margin requirement. If you get a margin call, it is because the market is signaling that you are incorrect regarding your trade. You do not want to throw more money into a bad situation. More times than not, you will be happy you cut your losses short and sold the stock (or covered it if you were short).

Interest

Brokers do not provide margin for free, this is capitalism. Brokers will charge you interest daily for your positions. This interest rate is much lower than a standard loan, but nonetheless it is money out of your pocket. So, it is in your best interest to use margin for short-term trading activities to avoid the fees.

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Accelerating Your Investments with Margin Lending

Margin lending allows you to borrow some of the money you require for an investment, this allows you to take out larger investments which have the potential to lead to higher returns on your investment. When deciding if you should use margin lending to boost your investments though there are a number of factors you should consider.

So How Does a Marginal Loan Work?

The way margin lending works is that the loan you take out is secured against the shares or managed funds you invest in. For example, you could put $15,000 of your savings into an investment and then get a marginal loan for a further $15,000 doubling your investment to $30,000. You can invest without dipping into any of your own savings funds if you choose. For example, if you had equity in your home you could use the equity in your home to buy the initial stock and then take out a marginal loan to double your investment.

Who Should Do Margin Lending to Accelerate their Investments?

Margin lending is for those who have more to invest and wish to increase their exposure to the market, but you should also preferably have a high disposable income and be willing to take greater risks. You should also ensure that you have enough to meet any margin calls that may be made on you.

How to Protect Against Risks Involved with Using Margin Lending

Although margin lending can help you to accelerate your investments it also poses greater risks than simply investing your own money. To help cover these risks you should not invest all your available funds and you should spread your risk across a number of different sectors. Due to the increased risk you should also carefully consider how much you are actually going to take in margin lending so that you can accelerate your investments while still remaining reasonably safe.

How to Choose a Margin Loan

If you are new to margin lending and are currently looking for a loan, or if you are looking to renew a margin loan, how do you go about choosing the right loan? You should first look at what you want to invest in, what the loan-to-valuation and buffer margins are, how the margin is operated and what other fees are associated with the loan, and the minimum loan amount. Carefully look at all the information you are given about different margin loans and weigh these up carefully before deciding which loan you are going to work with.

Margin lending is useful to boost your investments as it allows you to invest more than you currently have available and thereby get greater returns. There is however greater risk involved with margin lending and steps should be taken to minimize these risks and your margin loan chosen carefully taking into consideration all the information you can get on the loan.
About the Author

Written by Richard Greenwood, author of the ebook ‘Finance Overhaul’, a step by step guide to financial success and freedom. http://www.financeoverhaul.com.au