What is margin trading?
Margin trading refers to buying or selling securities using borrowed money from a broker. Brokers offer this service so people can purchase more than they would afford if they used funds in their bank account alone.
To open a margin account, you need at least $2,000 and the ability to provide documents that establish your identity and your address.
There are limitations on who can open a margin account due to laws designed to protect investors from losing too much money if something were to happen to the stock market.
The broker you choose will determine how much leverage you have, meaning they will set a certain percentage of your available balance for margin trading.
For example, if a company has a 50% margin rate and you deposit $1,000 in your account, you will be able to purchase up to $2,000 worth of stocks with that money.
Using margin for trading: How to trade with margin
Margin trading can be used as a strategy with discipline and patience if done correctly. It is essential to understand what opposing positions are and how they work in this context.
A negative position refers to an investor borrowing from their broker to purchase an asset but does not have enough funds to cover the purchase.
If an investor were to open a margin account with $1,000 and the broker has a rate of 50% on purchases, this means they can make any purchase up to $2,000. If you wanted to trade more than that amount, you would need at least double the amount of money in your account.
For example, if it is $1,000 per deposit on your margin account, you could only afford to buy up to about $500 worth of stock before buying opposing positions (50% x 500 = 250). If, after purchasing those stocks, there was a price increase but not enough for you to sell them all off without losing some money, then you would be left with an unfavourable position.
Every stock has specific rules on how much you can borrow and what percentage of the purchase price you must have to sell it off ultimately.
If not, your broker will automatically close out those positions for you, and you will essentially lose all the money spent on the trade. The part of the purchase price that is not covered by your credit can be called a margin call.
Back to the example: If after buying $500 of stock, you do not have enough money to cover the rest of your purchase, the broker will automatically close out those positions and sell all your stocks. Now you’ve lost $500 in addition to any fees that were associated with closing out your position (which can be significant).
That is why it is essential to know and understand how margin trading works before using it as a strategy.
When opening a margin account, the goal is usually for making quick and significant returns on investments.
It means taking more risks than one would take if they only used their funds, leaving you with opposing positions quickly. If done successfully, though, this could mean higher profits than what you could make through other investment strategies.
This strategy is only advisable if done with proper research and a significant amount of experience. Before using it as a strategy, reading up on the pros and cons of opening a margin account is recommended.
When opening a margin account, it will be essential to know what currency to trade (USD, EUR, etc.), how much leverage you have (50%, 100% etc.) and how opposing positions work. Read up on the pros and cons of this type of trading before considering its use as a strategy.
Ideally, you should not lose money or end up having opposing positions in your margin account.
For those reasons, this strategy may not be for beginners and should only be done by people with experience.