Margin Trading

Margin means borrowing money from a broker to buy a stock, or commodity, or currency pair and using the investment as collateral. It is, to all intents and purposes, a performance bond in cash or another means of security deposited by a trader. Investors generally use margin to increase their purchasing power to allow them to hold more stock or take larger positions in the market, without completely paying for it. However, margin also exposes investors to the potential for far higher losses.

The concept of trading on margin has been in use amongst professional traders throughout the Twentieth century and into the Twenty-First. In recent years there has been a growing community of so-called market experts who participate in day trading and tend to be the major users of margin trading or ‘leveraged’ trading via new companies that provide trading services for such traders or those who rely on the Internet to connect to trading sites.

For example, if a trader buys a stock for $50 and the price rises to $75, if the trader bought the stock with a cash amount and paid in full, the trader would make a 50% return. But if the trader bought the stock on margin—paying $25 cash and borrowing $25 from the broker—the trader will have made a 100% profit on the money invested, while owing the broker $25 plus interest.

However, the downside of using margin trading is that if the stock price decreases, considerable losses can mount quickly. If the stock bought at $50 falls to $25 and the trader paid for the stock in full, the trader merely loses 50% of their money. But if the trader bought on margin, he or she will lose 100% and still has to pay the interest on the loan. To make certain that the trader can carry the risk in the case of a loss a broker will typically require adequate collateral to cover potential losses.