The terms margin and leverage are often used interchangeably in the world of finance. While both terms refer to strategies that can be used to amplify an investor’s buying power when trading stocks and other securities, they have some key differences.
Margin trading, or “buying stocks on margin,” means borrowing money from your brokerage to purchase more stock than you could with your own funds. Your existing securities serve as collateral.
You will also pay interest on the amount borrowed from the broker.
Leverage is a broader financial concept, referring to the use of debt to take a larger position (whether in securities trading or business acquisitions) to potentially amplify returns. In the context of trading, leverage means using borrowing funds in order to increase trading positions — taking on more risk with the hope of more gains.
The use of leverage also means the possibility of losing more than you have. In addition to the risk of a trade going south, the borrowed funds must be repaid with interest. It’s important to understand how leverage works in terms of margin trading so that you know the amount of risk exposure you have.
Key Points
• Margin trading and leverage use debt to increase buying power and potential returns.
• Both methods significantly increase the risk of substantial financial losses.
• Leverage can be applied through various financial instruments, not just margin accounts.
• Margin trading involves borrowing funds from a broker, increasing exposure.
• With a margin account, the borrowed funds must be repaid with interest, regardless of the outcome of the trade.
Leverage vs Margin
The reliance on borrowed funds, or debt, to enable bigger trades or purchases is commonly known as leverage. Margin trades are a type of leveraged trade.
What Is Leverage?
The use of leverage refers to investors who use debt to finance bigger positions.
The same is true in business: a highly leveraged company is one that has taken on large amounts of debt to fund an expansion or acquisition; in other words, a company with a high debt ratio.
What Is Margin?
Again, margin is a type of leverage. Investors use margin, i.e., borrowed funds, to place bigger trades than they could afford with cash. The securities in their brokerage account are used as collateral for the margin loan.
Margin, or margin accounts, can be set up through a traditional brokerage account or when investing online. Access to margin is highly regulated in terms of how much investors can borrow, and how much collateral is required to place a margin trade.
Investors can use leverage via other means (e.g., leveraged ETFs, which do not require margin accounts).
Recommended: Margin Trading vs Futures: Compared and Explained
A Closer Look at Margin
Margin trading is a sophisticated, higher-risk strategy that enables experienced investors to trade securities using money that they’ve borrowed from their broker. As noted, margin can allow bigger trades, with the potential for bigger gains — as well as the potential for steep losses.
For investors who qualify, a margin loan generally allows them to borrow up to 50% of the cost of a trade. Like any other loan, margin funds require collateral from the existing cash and securities in the account; in addition, the loan accrues interest. Margin interest rates fluctuate and are generally decided by the broker.
Traders must also maintain a minimum balance in their margin accounts called maintenance margin. Along with collateral, this can cover potential losses.
The Margin Call
If the account falls below that threshold, the broker can require a deposit to bring the balance up to the minimum amount. This is known as a margin call. If the investor fails to cover the shortfall, the broker can sell securities in the account to restore the necessary balance.
How Margin Trading Works
When using a cash account vs. a margin account to execute trades, every cash trade is secured by moneyfo in the investor’s account, entailing no risk to the broker.
With margin, though, a portion of each trade is secured by the initial margin (or cash), while the rest of the trade is covered by borrowed funds. If the margin requirement is 50%, and you want to place a $10,000 trade, you would need $5,000 in cash.
So while margin trading affords more buying power than investors could achieve with cash alone, the additional risk exposure means that investors always need to maintain a minimum level of collateral to meet margin requirements, or they may face a margin call.
Though margin requirements vary by broker, following are minimums currently required by financial regulators.
| Term | Amount | Definition |
|---|---|---|
| Minimum margin | $2,000 | Deposit amount needed to open a margin account |
| Initial margin | 50% | Percentage of a trade that must be funded by cash |
| Maintenance margin | 25% | Minimum amount of equity in the margin account |
| Margin call | Any | If a margin account falls below the maintenance margin, the broker will require a deposit to cover the shortfall, or will sell securities in the account to do so. |
As noted above, margin trading offers experienced investors some potential upsides as well as risks.
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Pros:
• Increases buying power
• Potential for returns
• Can provide an opportunity for diversification
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Cons:
• Must meet and maintain margin requirements
• Potential for steep losses
• Investors owe interest on borrowed funds
Increase your buying power with a margin loan from SoFi.
Borrow against your current investments at just 11%* and start margin trading.
*For full margin details, see terms.
A Closer Look at Leverage
Leverage in finance is a word used to describe borrowing money to increase returns. Investors might borrow capital from a broker or bank in order to make trades that are larger than their account’s equity, increasing their trading power.
Companies might use leverage to invest in parts of their business that they hope will ultimately raise the value of the company.
How Leverage Works
Leverage in a stock account is the result of borrowing money to trade securities, using an account’s margin feature. Leverage can work to the benefit or detriment of an investor depending on the movements of an account’s holdings.
Companies often use leverage to amplify returns on their investment projects, and the same logic applies to trading equities. You may see the potential for significant returns on the upside — or you may see your account value drop rapidly if the market moves against you.
Trading with leverage is riskier than strictly using your own cash, because there is the possibility of total loss.
Futures and forex trading often use higher leverage versus a margin account. Forex trading may allow a 1% initial margin. So a $1000 deposit would enable an investor to trade $100,000.
The initial margin amount required for a futures contract can range from 2% to 12%, depending on the commodity.
The Takeaway
Margin trading and leverage can be used to boost returns, but there are substantial risks to consider.
A margin account with stocks allows you to borrow against cash and securities when trading stocks online. Leverage measures the increase in trading power because of using margin.
It’s important to understand your personal risk tolerance before trading on margin and using leverage
If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.
FAQ
Is leverage the same as margin?
Leverage is different from margin. You use a margin account to increase your leverage ratio when trading stocks. Futures and forex trading requires a trader to post margin to use leverage.
Can you trade without leverage?
You can trade without leverage, using securities with cash in your account instead. This method also avoids paying interest on margin balances. The downside is you will not be able to amplify returns as you would when trading on margin or with leverage. You can also trade leveraged ETFs without a margin trading account.
What is margin in stock trading?
Margin in stock trading happens when an investor takes out a loan on an investment with the goal of seeing that asset’s price rise. When the investment is sold, the borrowed funds are returned to the lender, but you as the investor keep the profits. The downside is if the security’s price drops, you will see enhanced losses. In either event, you owe the lender interest on borrowed funds.
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