The Margin Account Explained: Opportunity, Risk/Reward
The Margin Account is a type of brokerage account that allows its holder to buy stock on margin by borrowing money through the broker.
There is an application process that has to be approved by the broker to ensure the applicant is eligible for a margin account.
Generally, for margin accounts, there is an account minimum of $2,000, that begets a 2 to 1 leverage, which means if you have $2,000 in the account equates to $4,000 in buying power.
Most margin accounts have a 50% requirement which means you have to put 50% of the cost of the trade before you are allowed to use margin.
Example: buy 1,000 shares of a stock at 10/share for a total trade price of 10,000, means put up 5,000 of account’s money to complete the transaction.
Some securities, like 3X leveraged ETFs, could require up to a 90% requirement, so if buying 10,000 worth then would have to put up 9,000 of account money to complete trade.
With a margin account some traders are subject to the PDT (patter day trading rule), which requires you to have a minimum of 25,000 in equity in your margin account if you place more than 3 day trades in a 5 day period.
If the account is labeled PDT then you will have to maintain that account minimum and if not, the holder will not be able to day trade.
If the minimum equity requirement is held in the account the holder will be given day trading buying power which is 4x more than normal amount.
So if one had 25,000 in the margin account then there is 100,000 worth of day trading buying power. But, day trading buying power does not allow for positions to be held overnight.
There is a benefit to opening a margin account as opposed to a cash account, it is increased buying power, which will give the trader the ability to trade larger size and make more money.
There are some major risk to using margin.
For instance, one can lose more money than held in the account and would be in debt to the broker in the amount of the debit balance.
Also, if positions are held over night on margin the account will be charged interest on the amount borrowed, which can nibble at profits.
Trading in a margin account is not for everyone and should be taken very seriously because it can ruin the account if not managed correctly.
If looking to open and trade a margin account, make sure you fully understand the rules and risks.
Trading on margin is very risky and can deplete your account quickly if not managed correctly. Risk management is an important part of trading and more so when using margin, protect positions with stop orders.
Remember, it is your money and your responsibility.