Hey Trader,
What is Margin Trading?
What exactly is margin? Is it risky? Should you trade with a margin account?
In this article, we’ll dive into the details of margin in day trading, the pros and cons of using a margin account, and how to use margin to your advantage to grow your accounts exponentially.
Margin vs Cash Account
Before we proceed, here’s a brief explanation of day-trading with a margin account vs a cash account.
Cash Account
A cash account is the most conventional type of investment account. Let's assume you have a $5,000 cash account. If Tesla (TSLA) is at $340, you could buy 14 shares with your $5,000. If you sell at $360, you make $20 per share, resulting in a $280 profit.
Margin Account
Now, what if you’re trading with a $5,000 margin account? Margin trading allows you to borrow funds from your broker, increasing your buying power. Instead of just $5,000, you could use up to $20,000 with 4:1 leverage.
If you buy Tesla stock and it bounces 20 points, you make $20 per share. On 30 shares, that’s a $600 return, using your own $5,000 of capital.
Benefits of a Margin Account
1. Using Leverage
The biggest pro of trading on a margin account is leverage. Margin accounts let you amplify your potential returns, as well as your losses. With 4:1 leverage, your $5,000 capital can become $20,000 of buying power for day trading.
2. Trade Settlement Periods
In a cash account, it takes two days for the capital used in a trade to return to your account. For example, if you bought 14 shares of TSLA and made a $280 profit, you would have to wait two days for the $5,040 to settle. During this period, you can’t trade with that capital.
With a margin account, you don’t have to wait for the cash to settle before reusing it. This is crucial for full-time day traders who want to take advantage of daily market opportunities.
3. Popular Short Selling
A major benefit of margin accounts is the ability to short sell. Short selling allows you to profit from falling stock prices by borrowing shares, selling them, and buying them back at a lower price. This opens up more opportunities regardless of market direction.
Risks of Margin Trading
While margin trading offers significant benefits, it also comes with higher risks. You’re trading with borrowed money, which means you can owe your broker if your trades go south. It’s crucial to understand the risks and manage them properly.
Margin Maintenance
Margin maintenance is the capital needed to keep your trading position open. If a trader borrows $5,200 to buy 30 shares of TSLA at $340, the total position is $10,200. If TSLA drops to $240, the position’s value is now $7,200, and the trader’s equity is only $2,000, below the broker’s 30% margin maintenance requirement.
Margin Call
If your account falls below the required maintenance level, you’ll receive a margin call, requiring you to deposit more funds or sell part of your position. If you don’t act quickly, your broker may liquidate your position to protect their loan.
Risk Management Tips
1. Do Not Over Leverage
Never use your full buying power. If you have $50,000 in your account, giving you $200,000 of buying power, only use a portion of it. If you’re new and have $5,000, only trade with that $5,000.
2. Follow Your Stops
A proper trading plan includes entry points, profit targets, and most importantly, stops. Following stops prevents one losing position from blowing up your entire account.
Should You Day Trade with a Margin Account?
Margin accounts are beneficial for professional traders who use them to maximize profits on both long and short sides. However, without proper risk management, you can lose your entire investment due to a margin call.
Remember, margin is a tool, not a guarantee of success. It’s not the margin that causes traders to fail; it’s the lack of discipline and risk management. A reckless trader can blow up both margin and cash accounts.
Conclusion
Trading on margin offers great potential but also requires great responsibility.
Whether you choose to use a margin or cash account, focus on disciplined trading and risk management.
With the right approach, you can leverage margin to enhance your trading success.
Happy Trading,
Anthony Speciale
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