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What Is Margin Trading?

Views 50362022.09.28
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Margin trading is a controversial topic which has divided many investors. While some believe that margin trading can be used to create a huge upside, others claim that it causes financial ruin for traders.

How can traders like you and I take advantage of margin trading to grow our account?

Let’s start by knowing what margin trading actually is, along with what it can and cannot do for you.

Key Takeaways

Margin trading refers to the practice of using borrowed money from a broker to invest.

Margin trading could amplify possible returns and losses on investment.

Margin trading increases investors' buying power, but also involves higher risk and may trigger a margin call.

Understanding Margin Trading

Margin trading refers to the practice of using borrowed money from a broker to invest. The term “margin” refers to the amount deposited with a brokerage when borrowing money to buy securities.

When buying on margin, the investor uses the marginable securities or cash in their brokerage account as collateral to secure the loan.

The collateralized loan comes with an interest rate that will be calculated periodically and charged.

Let’s take a simple example:

The initial margin requirement of your broker for a certain stock is 60%.

You wish to purchase $10,000 worth of the stock,

Your margin would be $6,000 (and the broker could loan you the rest).

How Does Margin Trading Work?

Although we use the term margin trading broadly, there are actually two types of trades involved. Margin traders are capable of using both types depending on their view of the market direction.

Buying Securities With Borrowed Funds

When you expect the price of the asset you’re trading to go up, you can borrow funds from your broker to help you purchase more shares.

However, the assets in your account will be used as collateral and you’ll have to pay the corresponding interest and fees.

Short Selling

On the other hand, you can also place a trade if you expect the price of the asset you’re trading to go down. This occurs when you borrow securities and sell them, planning to buy them back at a lower price and return them later.

This is also known as short selling. While the shares are borrowed, your assets will be used as collateral. During that time, you’ll also have to pay interest and fees.

Pros of Margin Trading

Increased Buying Power

The most obvious benefit of margin trading is that it increases an investor’s buying power. Margin trading allows you to borrow money, and therefore you can purchase more stock than you'd be able to normally with a cash account.

Here’s an example for you:

Suppose you have $10,000 in cash and the market price of a stock is $100.

With a margin of 50%, you can buy 100 shares with your own cash and borrow another $10,000 from your broker to buy another 100 shares.

The shares you previously bought are used as collateral.

Now you hold 200 shares ($100 per share) through margin trading, and the market value of your position is $20,000.

Higher Potential Returns

Increased buying power allows you to buy more securities than you could otherwise afford. The more securities you own, the greater your potential profit if those securities gain value.

Let’s continue the example from above:

If the stock price rises by 50% to $150 per share, the market value of your position becomes $30,000.

Since the funds you borrowed from your broker remains unchanged at $10,000, your equity rises to $20,000.

This effectively gives you a return of 100% on your initial capital of $10,000.

Cons of Margin Trading

Despite its potential upside, traders should use margin carefully and be aware of its risks.

Higher Risk

Borrowing money to invest is risky.

There’s no guarantee that an investment will succeed. Whether the securities you buy gain or lose value, you will have to pay back the borrowed amount. In some cases, you could wind up losing more money than was put into your portfolio.

Margin trading is best used by experienced traders who know how to control their risk and are confident of getting the market direction correct.

Interest Charges

Borrowing money isn't free. When you use margin to invest, you have to pay interest based on the amount of money that you’re borrowing.

Before investing on margin, investors should take the cost of it into account. The interest charges reduce gains on successful investments and increase losses from poor-performing investments.

Even if the shares you buy maintain their value, the cost of borrowing money can lead to losses if held for a long time.

Initial Margin & Maintenance Margin Requirements

If you want to trade on margin, you first need to post a certain amount of cash, securities or other collateral, known as the initial margin requirement.

The current initial margin requirement set by the Federal Reserve Board's Regulation T is 50%. However, some equity brokerage firms may set their initial margin requirement higher.

Once you trade on margin, enough value should be maintained in your margin account to meet the brokerage's maintenance margin requirement (or the margin call requirement), which is usually 25% according to the Federal Reserve Board's Regulation T.

If an investor's portfolio fails to meet the maintenance margin requirement, it could trigger a margin call, which may force the investor to either deposit additional funds or sell their investments.

Many investors fear margin calls as investors may be forced to sell positions at unfavorable prices.

3 Types of Margin

To help you plan your trades, we will explain the three types of margin. These include your initial margin, maintenance margin and soft edge margin.

The initial margin is the account equity required to open a position. If you want to buy $10,000 worth of shares with an initial margin requirement of 40%, you’ll need $4,000 of cash.

The maintenance margin is the account equity required to maintain a position. This is typically lower than the initial margin required. If the maintenance margin is 30% , you’ll need $3,000 of account equity (including open positions) to hold the trade.

The soft edge margin is the account equity level where forced liquidation will occur. Typically, a soft edge margin is raised on the day before a non-trading day. It is then lowered when trading days resume. Assuming a soft edge margin requirement of 20-30%, you will need $2,000-$3,000 of equity on a $10,000 initial position.

For moomoo, we have a feature that allows you to monitor your risk of a margin call. Inside our platform, you can always view the risk level of your trading account.

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Based on the risk level, you can decide to sell some positions or top up your account. Sign up for free to get access to free advanced monitoring and technical charting tools, featuring 62 technical indicators and 37 drawing tools across mobile and desktop.

Preparing To Trade On Margin

A margin account is needed if an investor wants to trade on margin.

This is different from a regular cash account. 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.

Each brokerage would have different requirements to qualify for margin trading and different terms for its services.

A brokerage can also set its own rules on interest rates and how much of your own money you must have in the account compared to borrowed money.

In margin trading, as the investor is using borrowed money, or leverage, both the losses and gains would be magnified as a result.

Is Margin Trading Really for You?

In conclusion, margin trading can offer great potential rewards to traders who know how to manage their risk and catch price movements.

However, a trader has to factor in the interest cost and keep enough capital in the account to avoid a margin call.

Traders should be confident in their skills before attempting to trade with margin.

For such traders, moomoo offers margin accounts on our platforms. The amount you can borrow is dependent on the risk associated with each stock.

You can sign up for a free account in the link here. Margin accounts are subject to approval by our team.

Note: Margin trading entails greater risk, including, but not limited to, risk of loss and incurrence of margin interest debt, and is not suitable for all investors. Please assess your financial circumstances and risk tolerance before trading on margin.

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This presentation is for informational and educational use only and is not a recommendation or endorsement of any particular investment or investment strategy. Investment information provided in this content is general in nature, strictly for illustrative purposes, and may not be appropriate for all investors. It is provided without respect to individual investors’ financial sophistication, financial situation, investment objectives, investing time horizon, or risk tolerance. You should consider the appropriateness of this information having regard to your relevant personal circumstances before making any investment decisions. Past investment performance does not indicate or guarantee future success. Returns will vary, and all investments carry risks, including loss of principal.Moomoo is a financial information and trading app offered by Moomoo Technologies Inc.In the U.S., investment products and services available through the moomoo app are offered by Moomoo Financial Inc., a broker-dealer registered with the U.S. Securities and Exchange Commission (SEC) and a member of Financial Industry Regulatory Authority (FINRA)/Securities Investor Protection Corporation (SIPC).In Singapore, investment products and services available through the moomoo app are offered through Moomoo Financial Singapore Pte. Ltd. ("Moomoo Financial SG") regulated by the Monetary Authority of Singapore (MAS). Moomoo Financial SG is a Capital Markets Services Licence (License No. CMS101000) holder with the Exempt Financial Adviser Status. This advertisement has not been reviewed by the Monetary Authority of Singapore.In Australia, financial products and services available through the moomoo app are provided by Futu Securities (Australia) Ltd, an Australian Financial Services Licensee (AFSL No. 224663) regulated by the Australian Securities and Investment Commission (ASIC). Please read and understand our Financial Services Guide, Terms and Conditions, Privacy Policy and other disclosure documents which are available on our websites https://www.futuau.com and https://www.moomoo.com/au. Moomoo Technologies Inc., Moomoo Financial Inc., Moomoo Financial Singapore Pte. Ltd. and Futu Securities (Australia) Ltd are affiliated companies.
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