Margin trading is a risky yet possibly fruitful form of trading strategy that involves borrowing money from your broker to buy stocks. The procedure is governed by certain guidelines laid down by the Federal Reserve Board, though some brokerages may implement stricter guidelines.
So, how do you go about buying stocks on loan and what are the advantages and disadvantages of doing so?
Margin trading involves opening a special account, known as the margin account. Next, you need to deposit at least $2000 in the account for it to become operational. Some brokerages may demand a higher amount. This deposit is known as the minimum margin.
After depositing the minimum margin, you can borrow up to 50% of a stock's purchase price. The other 50% of the price is paid by you and is known as the initial margin. According to the Federal Reserve Board, the minimum percentage of the stock's purchase price that you are required to deposit is 50% though some brokerages may ask for a higher percentage of the purchase price and lend a smaller portion of the stock's purchase price.
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What is essential to remember is that you may borrow less than 50% of the price of the stock as well, depending on your tolerance for risk.
The loans at which you buy stocks, just like any other loans, come along with an interest rate. But unlike regular loans, there is no particular time frame in which you are expected to repay the loan, as long as certain guidelines are met by your account:
- The stocks you buy or the ‘marginal securities', as they are called serve to act as collateral for the loans you take.
- You can buy more stocks with the sum of the cash deposited by you in the account, the cash borrowed and the buying power that the previously purchased stocks accord to your account.
- At any point, the equity of your account, which is the amount of money left when you subtract the loan amount from the total value of your account, must be equivalent to at-least 25% of the market price of the marginal securities in the account. Some brokers may require a higher percentage. This amount is known as the maintenance margin.
- When you sell stocks in a margin account, the proceeds go to your broker as the repayment of the loan until it is finally paid off.
- The buying power of your account is subject to change according to the change in the value of the purchased stocks in your account.
- The longer you buy and hold shares, the higher is the interest you need to pay off for the loan accrued. Therefore, margin trading is preferred for short-term investments so that it is more likely for you to earn a profit instead of running into losses paying the brokerage back.
- Greater buying power
- Greater chances of earning exaggerated profits if you pick the right stocks
- Greater risk- You stand to lose more than the amount that you have invested
- The margin call- You are likely to have no control over the stocks that are sold off if the equity value in your account falls below the maintenance margin amount
Stock trading can be carried out employing several strategies. Margin trading is one of the several stock trading strategies that traders can employ with the aim to accrue high profits at the risk of high loss, as well.
Article Source: http://www.articlesbase.com/day-trading-articles/margin-trading-using-leverage-to-magnify-profit-7214249.html
About the Author
The author has a major in finance and has been trading stocks for a decade. http://otcbully.com/make-money/
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