What is Margin Trading for Investors?
What is margin trading for new investors in the stock market? And, is it the right strategy for you? There are many ways to make money by trading stocks and creating margin accounts is certainly one opportunity.
However, what is it and how does it work? Let’s take a deeper dive into this unique trading strategy below.
What is Margin Trading for Beginners?
Are you looking to boost or enhance your gains in the stock market? And are you willing to take on larger risks? If so, trading on “margin” may be right up your alley.
So, what is margin trading to be exact? It’s the process of borrowing money from a brokerage to make an investment. The key difference is the total value of the position in comparison to the loan amount from the broker.
You’re essentially buying stocks with money you don’t have. And many brokerages will allow this if you have a few thousand dollars in your account.
With margin trading, you are required to deposit a percentage of the notional value of the stock you are buying. This gives you leverage to magnify your potential returns while taking on greater risk.
Under the Federal Reserve Board rule known as Regulation T (Reg T), you can borrow up to 50% of the purchase price on a margin trade. However, most brokerages require a much higher deposit for margin trading.
Brokerages can set their own standards for margin trading as long as it’s at least as restrictive as the Reg T rule. And you also have to consider the Financial Industry Regulatory Authority (FINRA).
FINRA requires a minimum deposit of $2,000 or 100% of the purchase price of a stock with any brokerage. Therefore, you must have at least $2,000 in cash equity or stocks to be approved for margin trading.
Example of Margin Trading
The best way to understand, what is margin trading, is through an example. So, let’s break this down as a single purchase.
Let’s say that you want to buy 500 shares of a stock that is currently trading at $75 a share. If you bought this with your own cash, it would cost you $37,500.
If you made this purchase through a margin trade, you might only need to account for half that price. The other $18,750 would be covered by the margin. This is the money you are borrowing.
Now what happens if the share price goes up or down after the trade? If the share price rises $5 on 500 shares, that’s an increase of $2,500. That’s nearly a 15% profit for you because the gain is based on the $37.50 per share you paid. It excludes the $37.50 per share that was borrowed from the broker.
That’s a really good return. But, the margin works in both directions. If the stock price drops by $5, you’d take on a loss of nearly 15% as well. That’s double the loss if you paid for the stock entirely yourself.
Investing in Stocks
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What is margin trading for Investors? It’s a strategy that can enhance both your potential returns and losses. Depending on your specific circumstances, this may or may not be the right choice for your portfolio. You could even lose more than the initial cost of the stock in the first place. Therefore, it’s important to do your research before making a margin trade.
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