Margin trading refers to trading or investing using funds borrowed from a brokerage. Investors should understand that trading on margin operates like a double-edged sword; while it allows you to potentially multiply your gains, it can also multiply your losses.
At its core, margin trading involves borrowing from your broker to increase your purchasing power. This allows you to buy well beyond the actual cash you have at your disposal. We’ll cover the mechanics of how this works, as well as the risks and benefits of undertaking such a strategy.
Key Points
• Margin trading is trading or investing with funds borrowed from a brokerage.
• Borrowing boosts purchasing power but requires interest repayment.
• Risks include high interest costs and margin calls, leading to forced sales.
• Margin trading may help some traders access more purchasing power.
• Margin trading is risky, and may be unsuitable for some investors, especially those with long-term strategies.
Understanding Margin Trading
Margin trading means borrowing funds from your broker and using those funds to buy securities. Any borrowed funds must be repaid, with interest, regardless of whether or not you earn a profit on your trade. If you’re wondering about the difference between leverage vs. margin, you can think of margin as a form of leverage.
When investing – be it online investing or otherwise – with margin, your broker will require you to post cash collateral to match a percentage of the funds you borrowed. This is known as the margin, and the exact amount is set by your broker, the type of security traded, and prevailing market conditions.
Risks and Benefits of Margin Trading
Here’s a rundown of some of the most obvious risks and benefits to margin trading:
| Risks | Benefits |
|---|---|
| Amplified losses | Increased purchasing power |
| High interest expense | Added liquidity |
| Risk of margin call | No set repayment schedule |
Benefits of Margin Trading
Some of the benefits of margin trading include:
Added liquidity: Assuming you remain inside of acceptable maintenance margin requirements, margin trading grants additional buying power to smaller cash balances, which can be useful if you don’t want to liquidate existing holdings.
No set repayment schedule: Unlike standard fixed loans, there’s no repayment schedule for repaying your margin loan. The interest accrues while your balance remains outstanding, and is only repaid once the position is closed.
Risks of Margin Trading
Some of the risks of margin trading include:
Debt risks: Trading or investing with borrowed money has its risks, as you could end up in debt to your broker.
High interest expense: Interest rates on margin loans can range from low single digits to as high as 11% or more, depending on your broker and the size of your margin balance. At best, this is a drag on investment returns; at worst, an additional cost you have to pay on a loss.
Risk of margin calls: If at any point, the value of your investments fall beneath a broker’s posted margin requirements, you will be required to deposit additional collateral to cover the shortfall. This is known as a margin call. Failure to meet a margin call can result in a forced sale of your security, additional charges, and other penalties as dictated by your brokerage firm’s policies.
Is Margin Trading Ever Risk-Free?
Under no circumstances is margin trading ever considered free of risk. The core precept of all investing involves risk, and leveraged strategies like margin trading increase risk exposure.
Unlike cash accounts, which limit your losses to the value of your initial investment, margin accounts can result in losses that exceed the value of your initial deposit.
Is Margin Trading a Good Idea for You?
Margin trading isn’t for all investors, and its suitability depends on both the scenario as well as the experience and knowledge of each individual investor.
Trading on margin can be useful when you have a high conviction short-term trade idea. It can also provide the benefit of additional liquidity when much of your cash is tied up in existing investments that can’t be quickly unwound.
When considering margin trading, investors need to be willing and able to absorb any potential losses associated with this strategy. Make sure you fully understand the dynamics of each trade before opening a margin position.
Margin Trading With SoFi
Margin trading allows traders and investors to increase their purchasing power by using borrowed funds to buy securities. But it’s critical that traders and investors keep in mind that using margin can swing both ways – that is, it can allow them to invest more money, but it could also lead to increased losses.
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
What are the downsides of trading on margin?
Trading on margin involves a number of possible downsides, including added interest costs, heightened portfolio volatility, and magnified losses that may exceed the value of your initial investment.
Do some people make a lot of money trading on margin?
Trading on margin can amplify your potential investment returns thanks to the added buying power it offers. However, this multiplier effect swings both ways and will amplify the size of your loss, should the market move against you.
Is margin trading a good long-term investment strategy?
Margin trading is a form of leveraged trading and therefore not recommended for long-term investors. Over extended periods of time, there’s a heightened risk that market volatility may force a margin call. Also, the added interest expense incurred by margin loans can act as a drag on your investment returns.
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*Borrow at 12%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
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