Margin Trading

Abstract

Margin trading allows an investor to own more stocks by borrowing money from the broker. In fact, the purchasing power of the investor is greatly enhanced. But as we know there are no free lunches, the broker shells out the money against the securities of the investor. The risks associated with trade on margin are many.

Margin trading provides several benefits like purchasing securities; rendering overdraft protection, sell securities short as well as access credit. This may be better understood by the following instance.

Illustrating margin trading:

If an investor is buying say, 500 stocks by investing as much as $10,000. If the investor opts for trading on margin, he will be able to buy more number of shares (more than 500), since he is entitled to borrow money for those extra shares from the broker he is dealing with. In this deal, the broker is also benefited. If the value of stocks increases, the investor (who had borrowed money from the broker) will enjoy more profits after returning the interest payable on the borrowed money. The broker does not lend the money without any benefits. The broker gives the loan amount to the investor against the securities for, which the investor is actually borrowing the money.

There are certain prerequisites in this regard. The investor has to deposit some amount with the broker. Generally, the amount may be $2000. This amount varies from broker to broker depending on the securities for which money is being invested. The fact is, the more money one deposits, the more the investor may borrow from the broker. It is also necessary that the investor should have some basic knowledge about investing in the stock markets.

Returns unpredictable:

Just as the profits are manifold, there losses are too. If the market soars, the returns will be good. On the other hand, if the markets plunge, the investor has to incur a huge loss. This is because the investor has to bear the loss not only of the investments he made himself but also return the amount he has borrowed from the broker. It may be such that the investor may have to liquidate some of the existing stocks to meet the debt and the loss.

Margin trading enhances the purchasing power of investors:

It is said that margin trading increases the purchasing power of traders/investors because it allows an investor to buy more than he was actually being able to afford.