WHAT IS MARGIN TRADINGÂ ?
What is Margin ?
Margin is the money borrowed from a brokerage firm to purchase an investment. It is the difference between the total value of securities held in an investor's account and the loan amount from the broker. Buying on margin is the act of borrowing money to buy securities. The practice includes buying an asset where the buyer pays only a percentage of the asset's value and borrows the rest from the bank or broker. The broker acts as a lender and the securities in the investor's account act as collateral.
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In a general business context, the margin is the difference between a product or service's selling price and the cost of production, or the ratio of profit to revenue. A margin can also refer to the portion of the interest rate on an adjustable-rate mortgage (ARM) added to the adjustment-index rate.
Understanding Margin
A margin refers to the amount of equity an investor has in their brokerage account. "To margin" or "to buy on margin" means to use money borrowed from a broker to purchase securities. You must have a margin account to do so, rather than a standard brokerage account. A margin account is a brokerage account in which the broker lends the investor money to buy more securities than what they could otherwise buy with the balance in their account.
Using margin to purchase securities is effectively like using the current cash or securities already in your account as collateral for a loan. The collateralized loan comes with a periodic interest rate that must be paid. The investor is using borrowed money, or leverage, and therefore both the losses and gains will be magnified as a result. Margin investing can be advantageous in cases where the investor anticipates earning a higher rate of return on the investment than what he is paying in interest on the loan.
For example, if you have an initial margin requirement of 60% for your margin account, and you want to purchase $10,000 worth of securities, then your margin would be $6,000, and you could borrow the rest from the broker.
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KEY TAKEAWAYS
Margin refers to money borrowed from a brokerage to trade securities.
Margin trading therefore refers to the practice of using borrowed funds from a broker to trade a financial asset, which forms the collateral for the loan from the broker.
A margin account is a standard brokerage account in which an investor is allowed to use the current cash or securities in their account as collateral for a loan.
The collateralized loan comes with a periodic interest rate that the investor must repay to the broker.
Leverage conferred by margin will tend to amplify both gains and losses. In the event of a loss, a margin call may require your broker to liquidate securities without prior consent.
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SPECIAL CONSIDERATIONS
Borrowing money isn't without its costs. Indeed, marginable securities in the account are collateral. You'll also have to pay the interest on your loan. The interest charges are applied to your account unless you decide to make payments. Over time, your debt level increases as interest charges accrue against you. As debt increases, the interest charges increase, and so on. Therefore, buying on margin is mainly used for short-term investments. The longer you hold an investment, the greater the return that is needed to break even. If you hold an investment on margin for a long period of time, the odds that you will make a profit are stacked against you.
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