What Is Margin Trading & How Does It Work?

The most common method for buying stocks is transferring money from your account to the brokerage account and then purchasing the stocks. However, some experts say that you can trade by taking debts to invest using margin trading.

However, this is a risky way to trade, and if you consider using it, you need to understand what it is and how it works.

What Margin Trading Is And What To Know

Margin trading is selling or buying stocks using borrowed money. Since you will be taking a loan to buy your stocks, you will lose some ownership and control of the investment to the broker giving you the loan.

Therefore, if your investment does not turn out as expected, the brokerage firm will sell your shares without consulting with you.

People use leverage when margin trading, the idea that you have the chance of making more money by buying stocks using borrowed money. According to SoFi Invest, some of the benefits you get from margin trading include:

● No repayment schedule

● More purchase power

● Potentially deductible interest

● It is a safety net when you don’t have cash

However, the risks are as high as the benefits because you stand to lose more than you invested. To qualify for a margin loan, you must maintain a certain level of securities and cash in your account, also known as the broker’s maintenance level. If the value of your securities falls and the collateral drops below the broker’s maintenance level, the broker issues you with a margin call.

That means that you have to bring back the account value above the maintenance level, and you can do that by selling equities or depositing more cash. If you miss the margin call deadline, the broker will choose which investment or stocks to liquidate to improve the value of your account.

Other risks that you face with margin trading include:

● Short-term sales which trigger tax bills

● Exposure to more loses

● It takes a hit to your credit score

● Unfavorable terms and interest rates

How do Margin Accounts work?

How do margin accounts work? Take an example of an investor who buys 100 shares worth $30 each with cash and 100 more shares on margin borrowing the share prices go up to $40; their investment is worth around $8,000, which means they have a $2,000 profit.

However, if the shares drop to around $10, the investment is only worth $2,000. If they sell the shares, they still need $1,000 to fully repay the broker, bringing them a total loss of $4,000.

That means that you have a chance to make a lot of profit or lose more than you invested. You need to have collateral before taking a margin loan like any other loan. Most brokers require that you maintain a minimum of $2,000 in your account before borrowing the margin loan. According to the experts at SoFiInvest, “There is no deadline to repay the loan, but most margin accounts require that you keep your account value above a certain threshold.”

To take a margin loan, you need to open a margin account. The broker only allows you to borrow based on the value of the assets you want to purchase and your collateral.

Usually, they will allow you to borrow 50% of the stock purchase price, depending on the amount you leave in your account. To determine the interest rate, brokers either subtract or add a percentage depending on the size of your loan. The larger the loan, the lower the interest rate.

Experts recommend margin trading for more experienced traders or when you are sure that the investment will pay off. It would help if you also consider consulting a financial expert to help you make the best decision.

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