When you start investing, you will have the choice to choose what kind of account you will be using. Expert reviews such as HQBroker Review and Platform Review say that you typically have two options—the cash and the margin account. And we’ll break down the latter. Read on.
What’s a Margin Account?
You can avail a margin account from your broker, and this kind of account enables you to borrow some money. You use that money to purchase securities.
If you want to shoulder 50 percent of the whole security price, and then borrow from your broker the remaining 50 percent, you can do so.
Your broker will then charge you with some interest from the money you borrow. Then, the security you have just bought will be treated as a collateral.
Using a margin account and doing margin trading are very helpful for many investors. They enjoy the following benefits:
Compared with the shares you can buy when using a cash account, the shares you can potentially own if you use a margin account are vast.
This also means that whatever small gains you can make will be doubled, tripled, and so on, depending on the margin and leverage you use. Small market movements can have big effects on your account this time.
You can use your margin account to diversify your portfolio or hedge away from risks. If you think that your portfolio is too saturated with a specific kind of stock in a sector or industry, you can use the borrowed money to place positions that will improve your diversification.
When we say carry trades, we refer to the borrowing at a lower interest rate and then investing in something that can give your higher returns. This way of trading is dominantly used in the foreign exchange market, though it doesn’t mean that you can’t use it in the stock market.
Although margin trading can definitely be advantageous, it can also cause some harm on your trades if you’re not very careful. Here are the risks you should face:
Though you can certainly gain more, you can also lose a lot if you use a margin account. This is because your losses will also be leveraged, which means a small downward movement can cause huge losses to your account.
If your margin falls below safe levels, or if the securities you buy experience a steep fall, you will then have to face a margin call. You should then be able to provide a substantial amount of cash or marginable stock once it happens.
If you cannot respond accordingly to the margin call and you cannot meet its demands, your broker may have to sell your margined securities. If this occurs in a bear market, your securities may be sold in a bad time and therefore can cause huge losses.
Like many other trading strategies and trading tools, a margin account and margin trading are not necessarily good or bad. Depending on the amount of knowledge you have and your familiarity with the overall market, margin trading can be a very helpful tool to quickly reach your desired success level.