Margin Trading: The Advantages
  1. Margin Trading: Introduction
  2. Margin Trading: What Is Buying On Margin?
  3. Margin Trading: The Dreaded Margin Call
  4. Margin Trading: The Advantages
  5. Margin Trading: The Risks
  6. Margin Trading: Conclusion

Margin Trading: The Advantages

Why use margin? It's all about leverage. Just as companies borrow money to invest in projects, investors can borrow money and leverage the cash they invest. Leverage amplifies every point that a stock goes up. If you pick the right investment, margin can dramatically increase your profit.

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A 50% initial margin allows you to buy up to twice as much stock as you could with just the cash in your account. It's easy to see how you could make significantly more money by using a margin account than by trading from a pure cash position. What really matters is whether your stock rises or not. The investing world will always debate whether it's possible to consistently pick winning stocks. We won't weigh in on that debate here, but simply say that margin does offer the opportunity to amplify your returns.

The best way to demonstrate the power of leverage is with an example. Let's imagine a situation that we'd all love to be in - one that results in hugely exaggerated profits:

We'll keep with the numbers of $20,000 worth of securities bought using $10,000 of margin and $10,000 of cash. Cory's Tequila Co. is trading at $100 and you feel that it will rise dramatically. Normally, you'd only be able to buy 100 shares (100 x $100 = $10,000). Since you're investing on margin, you have the ability to buy 200 shares (200 x $100 = $20,000).

Cory's Tequila Co. then locks in Jennifer Lopez as a spokeswoman and the price of shares skyrockets 25%. Your investment is now worth $25,000 (200 shares x $125) and you decide to cash out. After paying back your broker the $10,000 you originally borrowed, you get $15,000, $5,000 of which is profit. That's a 50% return even though the stock only went up 25%. Keep in mind that to simplify this transaction, we didn't take into account commissions and interest. Otherwise, these costs would be deducted from your profit.

Margin Trading: The Risks

  1. Margin Trading: Introduction
  2. Margin Trading: What Is Buying On Margin?
  3. Margin Trading: The Dreaded Margin Call
  4. Margin Trading: The Advantages
  5. Margin Trading: The Risks
  6. Margin Trading: Conclusion
RELATED TERMS
  1. Trading Margin Excess

    The funds that remain in a margin trading account that are available ...
  2. Buying On Margin

    The purchase of an asset by paying the margin and borrowing the ...
  3. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin ...
  4. Margin Call

    A broker's demand on an investor using margin to deposit additional ...
  5. Margin

    1. Borrowed money that is used to purchase securities. This practice ...
  6. Leverage

    1. The use of various financial instruments or borrowed capital, ...
RELATED FAQS
  1. Why is purchasing stocks on margin considered more risky than traditional investing?

    Learn why purchasing stocks on margin is riskier than traditional investing, although it can be more profitable when it is ... Read Answer >>
  2. What is a margin account?

    A margin account is an account offered by brokerages that allows investors to borrow money to buy securities. An investor ... Read Answer >>
  3. What happens if I cannot pay a margin call?

    Minimum margin is the amount of funds that must be deposited with a broker by a margin account customer. With a margin account, ... Read Answer >>
  4. How much can I borrow with a margin account?

    Understand the basics of margin accounts and buying on margin, including what amount investors can typically borrow for purchases ... Read Answer >>
  5. What is the difference between leverage and margin?

    In financial terms, leverage is reinvesting debt in an effort to earn greater return than the cost of interest. When a firm ... Read Answer >>
  6. Margin accounts are established to allow investors the ability to use leverage with ...

    The correct answer is a): A margin account allows you to buy additional securities by leveraging the value of your eligible ... Read Answer >>

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