Unlocking the Potential Benefits of Margin Trading 

Stock trading lets people benefit from fluctuations in stock prices. Any trader or investor is limited to the amount of funds in their account, but margin trading allows them to use additional funds. If you have $5,000 in your brokerage account, some firms will let you trade with $10,000 if you request margin trading. Traders can borrow money against their stocks and use this leverage to potentially increase returns. Understanding how margin trading works can help you use this resource to potentially grow your portfolio and manage risk along the way.

Margin Trading Explained

Margin trading is similar to taking out a loan against your portfolio. You receive extra capital and can use it in any way you desire. Some traders deposit these funds into a bank account and use them to cover home repairs and other expenses without selling stocks in their portfolios. Many traders use these funds to buy additional stocks and enter new positions. Traders can decide when to repay the debt because there is no set repayment schedule. 

10 Potential Margin Trading Benefits

Margin trading can present several benefits for traders, but like any investment vehicle, it comes with risks. Here are some potential advantages to keep in mind.

1. Capitalize on Leverage

Leverage can increase your gains. Your $5,000 can suddenly buy you $10,000 worth of stocks. Without leverage, you can buy 100 shares at $50 per share. If the shares rise to $55 per share, you will net $500 not including any fees or interest charges. However, leverage would allow an investor to purchase 200 shares at $50 apiece. If these shares went up to $55, it would translate into a $1,000 gain instead of a $500 gain. Leverage can allow margin traders to amplify potential gains in their portfolios. A margin investment calculator can provide further insight into how much an investor can gain from using leverage.

2. More Buying Power

How long would it take for you to double on your own? If you have a $10,000 portfolio and currently contribute $1,000 to your portfolio each month, it would take 10 months to contribute $10,000 and double your buying power. Margin trading lets you double your purchasing power overnight. Instead of trading with $10,000, you can start trading with $20,000. You can buy more assets with the same amount of capital.

3. May Be Useful When Share Price Declines

You don’t have to deploy margin right away. Some traders let margin sit in their accounts and wait for prices to fall. These investors can then acquire additional shares at discounts relative to how they were valued a few weeks ago. Margin trading can help investors embrace a dollar-cost averaging strategy with more funds. Lowering your cost basis makes it easier to break even on your investments.

4. Diversify a Concentrated Portfolio

Portfolio diversification is the hallmark of risk management. Buying several stocks and funds spread across several sectors helps manage risk. You can do this with any amount of money, but margin trading can expand your choices. You can spread money into more funds and individual stocks to increase your coverage and reduce volatility.

5. Easier Access to Ongoing Credit

Margin functions similarly to lines of credit. Credit lines have flexible repayment terms, and you do not pay interest until you borrow money against your margin limit. Some traders treat margin like a credit line and use it to cover purchases instead of selling stocks to achieve the same goal. This approach is especially beneficial if you have substantial capital gains on some of your investments and don’t want to pay taxes on them before you’re ready to sell them. Using margin give you another option from having to sell those assets.

6. Your Margin Will Grow if Your Portfolio Increases

If you contribute $1,000 to your portfolio, it can provide $2,000 worth of purchasing power. It’s important to remember you have to repay any margin you use. However, if you want accessible funds that function like a credit line, trading with margin can help. You won’t have to reapply continuously for margin.

7. Increased Cash Dividends

Many corporations pay dividends to reward shareholders for holding onto shares. The more shares you own, the more cash flow you receive during each dividend payout. Using margin can increase your cash flow by letting you purchase more shares. You can secure higher dividend payouts with the additional shares and reinvest the proceeds to increase the following dividend payout. Keep in mind, dividends are not guaranteed and are subject to change and elimination.

8. Low Interest Rates

It’s important to look at the interest rate of your margin before getting started. A high interest rate can offset the gains from extra dividends, but potential stock appreciation and dividend payments can potentially make up for it in the long run. Margin rates are variable, which means they fluctuate based on the indexed interest rate. A rising interest rate can catch some traders by surprise, but a lower interest rate makes margin trading more affordable. Many brokerage firms have scaling margin rates that decrease if you hold more money with them.

9. Flexible Repayment Terms

Brokerage firms have more flexible repayment terms than traditional banks. Borrowers can repay margin at their convenience, and interest will accumulate each month. Other loans have fixed monthly payment requirements and other requirements that provide less flexibility. However, if your account falls below a certain level, the broker can initiate a margin call. During a margin call, a broker can forcibly sell some of your assets to repay some margin until your portfolio reaches an acceptable percentage of margin. 

Just like with any loan, trouble can arise if you do not pay it back. You could be sued or have your wages garnished. Those risks aren’t exclusive to trading on margin, but you should keep them in mind. 

10. Avoid Trading Violations

Trading violations can occur if you enter and exit positions too quickly without waiting for the orders to settle — especially if you don’t have any settled funds in your cash position. Margin helps with this issue, but you need at least $25,000 in equity to day trade without incurring violations. The required $25,000 minimum can combine your cash position and eligible securities. These trading violations can restrict how you use your account and limit you to waiting for trades to settle before exiting them. 

You don’t have to worry about not having enough settled funds to cover trades. Margin trading can be useful for options traders when it may become necessary to exit a position on the same day as entering it.

Potential Risks of Margin Trading

Every financial product has risks, including margin trading. These are some risks to keep in mind if you are considering margin for your portfolio:

1. Incurring More Losses With Leverage

Leverage is a double-edged sword. It amplifies your gains, but it also increases your losses. A 5% loss can turn into a 10% loss, depending on how much leverage you use.

2. Being Unable to Meet a Margin Call

If you cannot meet a margin call, the brokerage firm can liquidate your assets and request that you repay the remaining balance. You will also face additional charges if you cannot fulfill the margin call.

3. Account Fees and Interest Charges

Fees and interest add up. These costs will reduce any potential profit. Traders considering margin should look for brokerage firms with reasonable fees and interest rates.

4. Forced Liquidations

If you get a margin call, the broker decides which assets to liquidate. The broker may liquidate assets with the highest capital gains, resulting in a higher tax bill. You can sell some of your stocks ahead of a margin call’s deadline to decide which ones you sell instead of having the broker select stocks to liquidate for you.

5. Rapid Cash Deposits May Become Necessary

You may have to deposit additional cash or securities in your account on short notice to cover market losses.

6. Triggering Capital Gains on Profitable Investments

You may be forced to sell some or all of your securities when falling stock prices reduce the value of your securities.

7. Margin Requirements Can Change at Any Time

Your brokerage firm can increase its margin requirements at any time and is not required to provide you with advance notice.

8. No Extensions on Margin Calls

If you get a margin call and don’t resolve it, then your broker will likely take immediate action. You are not entitled to an extension, even if your next paycheck arrives in a few days.

Capitalizing on Margin Trading

Margin trading allows investors to tap into leverage. They can purchase more shares with the same amount of funds and potentially achieve higher returns. Margin trading has increased risks to consider, but traders who learn to navigate margin trading may provide themselves with added flexibilities to execute their investment strategies.

Frequently Asked Questions