Investing on Margin: The Basics

Investing on margin is a high-risk proposition, but it can also bring in some substantial rewards. If you are considering investing on margin, you need to understand how the process works so you can avoid big losses. Here are the basics of investing on margin and how it works.

Margin

Investing with margin is essentially borrowing money so that you can purchase more shares of stock. If the price of the security goes up, you are going to be able to bring in bigger profits. If the price of the security goes down, you are going to lose big. Using leverage like this amplifies every movement in the price of the stock. 

Trading on Margin

In order to trade with margin, you are going to have to borrow the money from your broker. This means that you are going to need to speak to your broker about trading with margin. If they allow you to do so, they will either have you open a separate margin account or allow you to do it through your traditional trading account. You are going to need to at least $2,000 deposit for margin trading. Depending on your broker, you will be required to invest even more. The maximum margin that you can use at one time is 50% of the price of the transaction.

Paying Back the Broker

Since you are essentially taking out a loan for this process, you have to worry about paying back the broker at some point. Generally, you are allowed to keep the margin loan for as long as you want. However, you should know that they are charging you interest on the loan. This means that the longer you hold it, the more money it is going to cost you. Whenever you close out your trade, any profit is going to first go to the broker to retire the margin debt. 

Margin Call

Whenever you are in the middle of the trade, you have to keep a certain amount of funds in your account. This is known as the maintenance margin. If you fall below this maintenance margin in your account during a trade, one of two things can happen. One option is that the broker will call you and ask you to deposit more funds to fulfill the maintenance margin requirement. The other option is that the broker will perform what is called a margin call. This means that they will close positions in your account until you get back under the maintenance margin requirement. When this happens, you are going to lose money.

Example

Let's say that you have $5,000 to invest. With a 50% margin requirement, this means that you actually have $10,000 to invest with the power of margin. You decide to purchase a stock that costs $1 per share with the entire $10,000. the value of the stock then goes up to $2. You now have $20,000 worth of stock. You sell the stock and give back the original $5,000 that you borrowed and you are left with $15,000. You have basically tripled your money. You would also have to deduct interest from your winnings. 

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