Margin trading

Margin trading is investing in securities (usually shares) using borrowed money, with the securities used as collateral.

Margin trading is funded by brokers or banks. Banks need the cooperation of the broker through which the trading is done in order to track positions in margin trading portfolios.

Investors generally use margin to increase their purchasing power so that they can own more stock (and make a greater gain) than their own resources allow. Like derivatives, margin trading exposes investors to the potential for higher losses as well.

The lender usually agrees to lend an amount that can only fund a fixed proportion of the portfolio. The remainder will be funded by the investor to provide a buffer against the value of the portfolio falling below the value of the debt it secures.

When the value of a portfolio falls so low that the debt exceeds that fixed proportion the lender is willing to fund, then a margin call will be made. This means that the investor must either pay down the debt (putting more of their own money into the portfolio), selling securities, if necessary, to do so — or the broker will sell on their behalf.

Margin traders pay interest on the debt, which reduces net returns.

Copyright Graeme Pietersz © 2005-2016