Tag: buying on margin

  • Margin Call – How to Profit From The Trade

    Margin Call – How to Profit From The Trade

    Margin Call - The Dangerous Behind
    Every second in your account you must have 25% of the total price of the stock you hold to cover the maintenance margin.

    By Guy Avtalyon

    A margin call is something that every trader would like to avoid.

    • Buying on margin means borrowing money from your broker to buy stocks.
    • There is no profit without the risk involved.

    Have you ever seen a better movie than Margin Call? A movie about the Financial Crisis? It just crossed my mind when I started to write this. 

    Okay, never mind. The subject of this article is a margin call in the stock market. 

    Let’s start from the beginning.

    What turns around and around the stock market is a risk. I know that is the major problem for most of you. How to take the risk? Because the risk has its bright and dark side and you know that. For example, you are trading some stock without guarantees that it will perform well. 

    The identical risk that boosts stock prices one day can lower them tomorrow. Yes, the identical. Pretty scary. 

    But here we come to the bright side of the margin call. For investors who want to profit a lot and quickly nothing is better than buying on margin.

    Buying on margin means borrowing money from your broker to buy stocks. Basically, it’s a loan from your broker. 

    How “buying on margin” works?

    You can borrow from your broker up to 50% of the price of a stock. 

    For example, when the stock price is $20,000 you will pay $10,000 and your broker will lend you the rest which is another $10,000. 

    Let’s look at the possible scenarios. 

    Assume the stock price grows at $24,000. The return on your investment will be 40%. You invested $20,000, but you have to give back to your broker $10,000 and you will end with $14,000 in your hands. But you invested yours $10,000 so you will have $4,000 of profit. This is good and you can be happy because you made a profit.

     

    But things may go in another direction. 

    Assume the stock price went down at $16,000. You will end up with a 40% loss on your investment. Even more, you have to give back the borrowed money to your broker increased by charges, fees, and interest on the loan, of course. 

    Buying on margin may be extremely risky. You may lose your entire investment. But you may lose more because of something known as a margin call. 

    Every second you must have an adequate amount in your account to cover the maintenance margin. That amount is 25% of the total price of the stock you hold. 

    What can happen if you don’t have enough cash in your account? Your broker will issue a margin call. That means, your broker is demanding you to cover the difference with more deposit and reach that 25% maintenance level.

    Let’s go back to our example and situation when things went wrong. What will happen if the stock price drop at $12,000? Your loss is $8,000 and now you have only $2,000 in your account. The rule is that you MUST have 25% and $2,000 is not enough to cover that. So, you lost $8,000 and at the same time, you have to deposit an additional $500 in your margin account to stay in the market. Also, you have to pay back the money to your broker.

    Is margin call dangerous to investors? 

     

    It can be extremely dangerous. In our example the missing deposit is small as the money invested isn’t big, but you can count how it is an enormous loss when the value of the investment is $200,000, $500,000, or million dollars.

    The most frightful detail about margin call for you as new investors is that your broker has no obligation by law to warn you that your margin account is too low. So, what the broker will do?

    The broker will sell your stock and liquidate your assets if it is necessary. He or she needs to ensure the maintenance level in your margin account. Even more,  the broker can begin selling your stock even the margin call is issued. Such will not wait for you and will not give you a grace period. Damn, you are dealing with a un-patient broker. This is an extremely painful and dangerous situation. If you come up to this situation how will you earn your money back when the market turns in your favor. You have nothing to trade with.

    The other danger about margin call is that you do not have an influence on which stock your broker may sell. Of course, the broker will choose the best players to cover fast and smooth the maintenance margin. 

    Moreover, the brokerage may change the rules and issue the margin call based on them. You will not have even zero chances to delay paying the margin call.

    How to avoid the potential risk of a margin call

    First, stay away if you don’t have enough experience in trading. Second, open some other account for an emergency with enough money to cover the margin call.

    I can understand that you are willing to enter the market as a big player. At least to earn a big profit. Nothing is bad with that. Everyone wants the same. Just keep these things on your mind when you want to trade on margin. Buying on margin is an extremely exciting method, risky but with great potential to profit.

    If you are 100% sure that you have a great player in your hands, and don’t have enough money to buy it, do it. Borrow from your broker.  Sometimes, a great risk will bring a great profit. In the end, there is no profit without the risk involved.

  • Margin Trading Definition

    Margin Trading Definition

    2 min read

    Margin Trading Definition
    Margin trading isn’t without risks involved, so pay more attention to it

    Margin trading is simply the process where investors buy more stocks than they can afford to. It also refers to intraday trading in India and various stockbrokers provide this service. It can increase your profits on the upside, but also expand your losses on the downside. Margin trading means buying and selling stocks or some other assets in one single session. This process requires a trader to guess the stock change in a particular session. It is an easy way of making a fast buck. It is now accessible to even small traders.

    What is margin trading?

    Margin trading is also called buying on margin. It is a method of buying shares that involves borrowing a part of the sum needed from the broker executing the transaction. The collateral for the loan is normally securities in the investor’s account. The trader has to deposit an initial amount of cash or securities into a margin account with the broker. And has to keep a minimum amount of cash or securities in the account as collateral. If the balance of a margin account falls below the minimum maintenance amount, the broker makes a margin call to the trader for the funds needed. Margin balances can be adapted to follow market values by adding or subtracting variation margins.

    What is buying on margin?

    Buying on margin gives the investor leverage as any capital appreciation or dividend income is on the total amount purchased. Even after the amount borrowed has been repaid to the broker, with interest, the investor could still be better off than if he/she had personally financed the purchase of a smaller amount of shares. That depends on how much the shares gain and how much they yield. There are some risks with margin trading – if the shares fall in value, the investor suffers a capital loss while also facing potential margin calls from the broker.

    An example of margin trading

    Margin trading is meant for traders who are looking for a simple way to increase their earnings. And also, they have a reasonable level of risk appetite but do not have enough capital.
    Let’s say you are 100% bullish for the big company and believe the stock is going to pick up.  You want to buy 1000 shares of that company and each share is priced at $200. You would need a capital amount of $200,000 to enter that position.
    Assuming you have $150,000 and want to borrow the rest of the capital. With margin trading, your broker can help you with the rest of the funds while charging you a specific interest percentage.

    How does margin trading work?

    The whole process is quite simple. Margin trading is legal buying stocks or other securities, but instead of your own money, you borrow it from your broker.
    Think about buying stock on margin as buying a house with a mortgage. A margin account provides you the financial support to buy more stocks than you can currently afford. For this purpose, the broker will lend you money to buy shares and keep some amount as collateral.
    If a trader wants to trade with a margin account, the first requirement will be to request a broker to open a margin account. This requires paying a specified amount of money upfront and in cash. That is so-called the minimum margin. If a trader has a losing bet and ends in losses, and fail to pay the debt, the broker will get it out from the margin account.
    When you open the margin account, you’ll have to pay an initial. This is a specific percentage of the total traded value and pre-determined by the broker. Before you start margin trading, you need to keep in mind these important steps.
    First, you need to secure the minimum margin (MM) through the trading session. The reason behind this: if the stock is very volatile, the price can fall more than you had expected.
    Second, the broker has the right to ask you to increase the amount of capital you have in your margin account. Also, the broker has the right to sell any of your securities if feels its own funds are at risk. The broker can even sue you if you don’t fulfill a margin call or if you are carrying a negative balance in your margin account.

    Margin trading if the stock price goes up

    This is the best outcome for you.  Let’s do some math (I adore math).

    Say you bought 100 shares for $4000. But you had $2000 and broker loans $2000. If the price goes to $50 per share, your investment will be worth $5,000. Your outstanding margin loan will be $2,000. If you sell, the total proceeds will pay off the loan and leave you with $3,000. Because your initial investment was $2,000, your profit is a solid 50%. Your $2,000 principal amount generated a $1,000 profit. However, if you pay the entire $4,000 upfront without the margin loan your $4,000 investment will generate a profit of $1,000, or 25 percent. By using a margin, you could double the returns.

    The stock price fails to rise

    If the stock stays at the same price, you still have to pay interest on that margin loan. You are in a better situation if the stock pays dividends because that money can pay some of the costs of the margin loan if not all. In other words, dividends can help you pay off what you borrow from the broker.

    Margin Trading 1
    When the stock doesn’t change in price it is a neutral situation, but you’ll pay interest on your margin loan for each day. Margin trading can be a good plan for traditional investors if the stock pays a high dividend. Many times, a high-payed dividend, for example, $5,000 worth stock, can exceed the margin interest you have to pay. For example, if you had $2.500 and you borrowed the other $2,500, which is 50% of stock’s value. But you expect to receive $3.000 as a dividend, so you’re safe.

    Margin trading when the stock price goes down

    If the stock price drops, buying on margin could work against you. What if the price in our example goes to $38 per share?
    The market value of 100 shares will be $3.800. So, your capital will shrink to just $1,800 because you have to pay your $2,000 margin loan to your broker. This isn’t real trouble at this point, but you should be cautious. The margin loan is 50% of your investment. If it goes lower, you may get the margin call. The broker will demand you to keep the ratio between the margin loan and the value of the securities the same as it was when he lends you money. That’s why margin trading can be very dangerous.

    How to maintain the balance in margin trading?

    When you buy stock on margin, you must maintain a balanced ratio of margin debt to equity of at least 50 percent. If the debt portion exceeds this limit,  you’ll be required to restore that ratio by depositing either more stock or more cash into your brokerage account. The additional stock you deposit can be from another account. If you can’t come up with more stock, other securities, or cash, you have to sell stock from the account and pay off the margin loan. For any trader, it means having a capital loss. For you also, because you lost money on your investment.

    The bottom line

    As you can see,  the margin can increase your profits on the upside but also increase your losses on the downside. If your stock drops drastically, you can end up with a margin loan that exceeds the market value of the stock you used the loan to buy. In the bear market of 2000, for example, many people realized stock losses. The majority of these losses came as a consequence because traders did not manage properly the obligations associated with margin trading. To avoid this kind of problems you must have sufficient reserves of cash or marginable securities in your account.
    For example, buying dividend yields that exceed the margin interest rate could be the right choice so the stock could pay for its own margin loan. Just keep in mind to set up your stop-loss orders. Your goal is to make money, and paying interest could eat your profits.