Trading on Margin Is Powerful but Dangerous

Trading on margin is a process that involves borrowing money from your broker and using that money to purchase additional stock. This allows you to increase the potential of each investment by increasing the number of shares that you can buy. Even though this investment strategy can be very powerful, it can also be very dangerous and can amplify your losses. Here are a few things to consider about trading on margin.

Trading on Margin

Trading on margin is a strategy that has been used by many investors for years. In order to engage in this activity, you may need to open a special account with your brokerage. If you are allowed to open a margin account with your broker, the broker will then provide you with a maximum amount of margin that you can acquire. This is essentially like having a line of credit to work with in your trading. If you decide to make a trade, you can borrow money from your broker in order to increase the amount of shares that can be purchased with each trade.

Margin Requirements

In order to trade on margin, you will have to make sure that you meet the appropriate margin requirements. Every broker will have their own margin requirements that must be met. This means that you have to keep a certain amount of cash in your account in order to meet these demands. Most of the time, you have to meet a 1:1 ratio of available funds to borrowed funds. This allows you to double the amount of money that you would normally be able to invest.

Potential

Using this strategy successfully can help you make a lot more money than you would ordinarily be able to make. You are essentially able to double your profit potential with this strategy. For example, let's say that you have $10,000 to invest in the market. You find a stock that is worth $10 per share. With your own money, you can buy 1000 shares. After you make a purchase, the price of the stock increases to $20 per share. This means that your investment would go up to $20,000 in value. If you had used margin trading, you could put up your $10,000, and get another $10,000 from the broker. This would then give you an investment that was worth $40,000 after the price of the stock increased. When you pay back the broker, you would actually have $30,000 which means that you tripled your investment, instead of only doubling it.

Risk

At the same time, trading with margin can make the losses hurt a lot worse than if you simply traded on your own. For example, let's say that you invested $10,000 in the same stock. If the price went down to five dollars per share, you would lose $5000. If you used the same amount of margin and the price went down, the value of your investment would now be $10,000. However, you now owe the broker $10,000. This means that you would lose everything if the value of the investment decreased by 50 percent. 

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