Margin is money that a trader borrows from a broker to invest, and is calculated as the difference between the total value of an investment and the amount of the loan. Margin trading allows a trader to use leverage and trade with volumes much larger than otherwise.
How can I use margin when I trade stocks?
- You can use margin as leverage to amplify your gains, as trading on margin allows you to be able to buy more stocks that you'd be able to otherwise. For example, today, Apple's stock is trading at $115.32, and you want to buy 100 shares of it. Traditionally, the initial margin is 50%, so you only have to fork out $5,766 from your account and borrow the other $5,766 from your broker to purchase the stocks. If the stock rises by 25% to $144.15, you will earn $14,415, and after paying the $5,000 back to your broker, you will have made $8,649 which is a return on investment (ROI) of 150% on your initial margin.
- However, margin trading can also amplify your losses. If Apple's stocks fall by 25% instead to $86.49, you will earn $8,649, and after paying back the broker the $5,766, you are only left with $2,883, which is a loss of 50% on your initial margin, two times more than if you had not traded Apple's stocks on margin.
- Most importantly, you must keep in mind the "maintenance margin", which is the minimum balance you must keep before your broker forces you to either deposit more funds or close your position. When this happens, it's known as a "margin call". If you do not meet the margin call, your broker or trading app can close out any open positions. They can do this without your approval and can choose which position(s) to liquidate.
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