Margin trading & short selling

1. Margin trading & short selling

Margin trading: Involves borrowing money from your broker to purchase securities, which uses your account assets as collateral. However, it's essential to remember that margin trading comes with interest charges and fees.

Short selling: Involves borrowing shares from your broker and selling them in the hope of buying them back at a lower price in the future. Your account assets are used as collateral for this transaction, and there are interest charges and fees that apply. Eventually, you must return the borrowed shares to your broker by purchasing them on the market.

2. Why do investors use margin trading & short selling

2.1 Why do investors use margin trading

The most significant advantage of margin trading is that it can amplify your returns on investment.

Example

Suppose you have $10,000 in cash, and the market price of a stock is $100, with a margin requirement of 50%. You can first buy 100 shares with your own cash, and borrow $10,000 from Your broker to buy another 100 shares. The shares you previously bought will be used as collateral.

Now you hold 200 shares ($100 per share) through margin trading, and the market value of your position is $20,000. If the stock price goes up by 50% to $150, the market value of your position becomes $30,000. While you owe Your broker $10,000, your net assets become $20,000.

2.2 Why do investors engage in short selling

Short selling is a strategy commonly used when you believe the price of a stock is about to fall. You borrow the stock from your broker and resell it on the market. When the stock price falls, you buy back the stock and return it to your broker, and earn the spread as your return.

Example

Suppose the market price of a stock is $100 per share, and you think the stock price will fall in the future. You borrow 100 shares of the stock from a broker and sell them. Now you have $10,000 in cash after the sale, but the number of shares you hold becomes -100. When the stock price drops to $50, you only need to spend $5,000 to buy 100 shares and return them to your broker. The $5,000 spread is your return on short selling.