Buying on Margin
Buying on Margin
Buying on margin gets popularity during every strong bull market. Unfortunately, it becomes most popular when the bull market is close to an end.
So what is buying on margin (or margin trading)? Buying on margin is securities trading when securities are acquired partly by own capital, partly by borrowed capital. In other words it is a securities trading using financial leverage. If you wonder why people do that, the answer is very understandable, they want to profit more.
The math is simple here. For example, an investor has $5,000 cash and he believes very strongly in stocks of some company. He believes in it so much, that he would use a credit if opportunity would occur. And buying on margin is exactly that opportunity. So the investor buys selected stocks for $10,000 using $5,000 of own equity and other $5,000 of borrowed capital. If he is right and stock price go up, he sells those shares for a $20,000 and after he repays the credit, he has in the account $15,000, so his return on investment will make 200%. If he wouldn’t use financial leverage and would buy stocks without margin (for $5000) then investor would have $10,000 and that would make “only” 100% return on investment.
Theoretically almost all kind of securities may be bought on margin; however, in practice margin trading mostly is used for stock trading or for some equity funds. If investor would buy some bonds on margin it would not make that much sense, because interests for borrowed money may be higher than interests paid by bonds.
Buying on margin is based on collateral which is provided by investor. Collateral is stocks (or other securities) or cash that is in the trading account. If investor buys more stocks, those stocks also become a collateral if are on the list. Not all securities are recognized as collateral and it depends on margin trading service provider (brokerage firm). Also different collaterals may have different coefficients which will have influence to allowed size of credit.
Size of the margin varies in the market and also depends on brokerage firm. Some firms allow higher margin, some lower but the most common margin allows doubling your investments. For example, if you have $1,000 then you may acquire investments worth of $2,000 but only if all acquired investments are accepted as collateral. If some of securities won’t be accepted as collateral then total invested amount will be lower.
Buying on margin in our days is very user friendly and comfortable. Investor simply agrees with the rules and buys stocks on his trading platform. In the same platform he can see what is value of his own equity, what is total invested amount, what is value of collaterals and what is his debt. It is easy to manage such account and react fast to the changes in the market. Buying on margin (margin trading) has evolved from repo (repurchase agreements), which in their meaning are almost the same, only in different and not so comfortable form.