When you invest in stocks, you must open a brokerage account first. And after that, you’ll have to choose what your trading account will be. Brokerages offer a plethora of options, but we’ll tackle one kind. What’s a Margin Account? And what benefits can you get from such account? What are the risks?
In this article, let us take a look at the basics.
Margin Account: the Advantages
A Margin Account lets you borrow some funds from the broker to buy additional securities, but with credit. This is also known as buying on margin. Meanwhile, if you use cash account, you’ll have to fund your purchases using only the money available in your account.
Oftentimes, the broker lets you borrow up to half the purchase price of a stock. This means that you can buy twice as many stock shares. That is, if you grab the chance and take full advantage of your margin limits. You’re basically using the broker’s money, so you would probably use leverage.
But take note: using leverages will amplify both your potential gains and potential losses. You should be very careful when using this double-edged blade.
Another good thing about a Margin Account is that it enables short-selling. Short-selling gives margin traders more flexibility than cash traders. Plus, you can access several advanced option trading strategies, which may not be available in other types of accounts.
Margin Account: the Disadvantages
To make it clear, disadvantages are inherent in all forms of trading and in any kind of strategy. So it’s imperative to point out the following flaws that can be found in using a Margin Account.
For one, margin fees range from 1 percent to 10 percent yearly. It depends on the brokerage and the account size. Expect enormous headaches if you forget to consider this.
And since trading on margin is a form of loan, you’ll have to pay interest on the margin you use.
There’s also this thing named “margin call,” where you’ll be notified if the value of your margin falls below a certain level—the safe margin level—or the account minimum. Typically, brokers require a minimum of $2,000 in assets in a margin account at any given time.
Your account’s equity will be the “collateral” on your margin loan, so if the equity value slides to its lowest, your broker may require you to sell some assets or deposit more cash.
How to Strategize in a Margin Account
No one strategy fits all kinds of investors. If you’re going to use a Margin Account, there are things that you should keep in mind.
Check your risk tolerance. Risk tolerance is basically the amount of risk or uncertainty you’re willing to take on. It goes without saying that you must use realistic standards in assessing your risk tolerance. Using a Margin Account is already risky in itself.
Remember that using a Margin Account becomes a smart move if you can withstand plenty of risks and if you’re willing to try more advanced options strategies.
Carefully consider those things before opening an account and giving margin trading a shot. Make sure you’ve prepared your strategies and you’re willing take on the challenges and uncertainties ahead.