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: Managing Risks
  7. Margin Trading: Conclusion

The risks of margin trading include...

 

Risk of amplified losses:

As mentioned earlier, margin trading can amplify gains as well as losses. The example below shows how it is possible to lose more than 100% of your investment in margin trading. A loss of $10,425 on a $10,000 investment means that in addition to losing his or her entire $10,000 investment, the trader is also on the hook to the brokerage for an additional $425. If the stock plunges to zero rather than $50 after six months, the total loss would be $20,425 and the ROI -204.25%. In this scenario, the trader has not only lost the full $10,000 investment, but also has to repay the brokerage the margin loan of $10,000 plus the interest charge of $425. Note that a debt obligation to a broker is as binding as a debt obligation to any bank or financial institution, and must be repaid in full. (Related: Risks And Rewards Of Margin Investing)

Margin call

As discussed earlier, if the securities bought on margin abruptly have a sharp decline (or in the case of a short sale, if the shorted security spikes in price), the investor is faced with a margin call and may have to come up with a substantial amount of cash or marginable stock at short notice. (Related: Why is purchasing stocks on margin considered more risky than traditional investing?)

Forced liquidation

If the investor cannot meet a margin call, the brokerage can and will sell the margined securities without further notice. In a plunging market, forced liquidation this may result in the investor’s position being sold at the worst possible time and generating a large loss. To add insult to injury, if the margined securities eventually turn around and end up being back in the black, the investor would have been needlessly “whipsawed.”

Interest charges and rate risk

Margin accounts have a fairly high rate of interest. The interest cost on margin debt can add up over time and significantly erode the gains made on margined securities. In addition, interest rates on margin debt are not fixed but can fluctuate during the time that an investor has margin debt. In a rising interest rate environment, the interest rate on margin loans will head higher, adding to the interest burden for investors engaged in margin trading.

Extra vigilance in account / portfolio monitoring

Margin trading requires an investor to be extra vigilant in monitoring the margin account or portfolio, to ensure that the margin does not fall below the required level. This can be especially stressful during periods of enhanced market volatility.

 


Margin Trading: Managing Risks
Related Articles
  1. Insights

    Margin Debt Hits all-time High: Time to Panic?

    Margin debt and equity prices: a case of the chicken or the egg?
  2. Trading

    A Guide to Day Trading on Margin

    Buying on margin is a good option if you don't have the cash to day trade.
  3. Managing Wealth

    What's a Good Profit Margin for a Mature Business?

    How to determine if the amount you clear dovetails with the competition.
  4. Small Business

    How Gross Margin Can Make or Break Your Startup

    Find out how your startup's gross margin can impact your business, including why a mediocre margin may spell disaster for a budding business.
  5. Investing

    Leverage: Is It Good for Your Portfolio?

    Discover the concept of financial leverage. Learn multiple ways to get leverage in your portfolio, and decide if leverage is a good idea for you.
  6. Insights

    Do Declining Corporate Margins Point To Recession in 2016?

    Learn how declining profit margins have foretold nearly every recession of the past 50 years, and analyze whether they may signal economic contraction in 2016.
  7. Investing

    The Difference Between Gross and Net Profit Margin

    To calculate gross profit margin, subtract the cost of goods sold from a company’s revenue; then divide by revenue.
Trading Center