Margin trading refers to the process of borrowing funds from TradeStation in order to leverage your available capital to trade stocks and options. Margin accounts are required if your trading will include short-selling stock or writing options, and you must open a margin account with at least $2,000.
Margin trading can only be accomplished in an account known as a margin account, which is different from a cash account. While stocks and options can be purchased in either cash or margin accounts, short sales of stock can only be traded in a margin account.
Margin trading incurs interest charges and these charges are debited from your account. Normally it is used for shorter-term trading as the longer you hold a position the greater the cost which can reduce the overall return on an account.
Margin trading involves increased risk, and is regulated by the Federal Reserve Board, the New York Stock Exchange (NYSE), and the Financial Industry Regulatory Authority (FINRA). Each brokerage firm also maintains margin policies that are in the best interest of the brokerage and their clients.
Maintenance margin is the minimum amount of equity that must be maintained in a margin account. Once a trader or investor has borrowed on margin to buy or sell a stock, the minimum required level of margin is 25% of the total market value of the securities in the margin account. Brokerages may have higher maintenance requirements depending on market conditions.
Example of buying stock on margin
A customer deposits $30,000 in their margin account. The initial margin requirement for trading stocks is 50%, which doubles the buying power in the account to $60,000. Remember the maintenance margin requirement is 25% which means the account value may not dip below 25% of the value of the securities.
Buying on margin
A customer with $30,000 in their margin account buys 500 shares of a stock trading at $100 per share. The value of this transaction is $50,000 (500 shares x $100). The customer must borrow $25,000 from the broker to make this purchase and must also put up $25,000 cash in their account as the initial margin. This leaves the customer with $5,000 in cash or $10,000 is Buying Power.
For this example the maintenance margin is calculated by taking the amount borrowed; $25,000, and dividing that by .75. That calculates to $33,333 which is the minimum value of cash and securities that must be maintained in the account to avoid a margin call. Another way of looking at this is that the stock purchased for $100 per share must stay above $67 per share to avoid a margin call. ($33,000 / 500)
If the stock and option positions in an account go against the trader and their equity falls below the maintenance margin; the broker will initiate a “margin call” and ask the customer to deposit more cash to into their account to cover the shortage. Also, keep in mind, at the brokerage’s discretion, positions can be liquidated to cover an outstanding margin call.
Pros and Cons
The main advantage of margin trading is that is allows customers to leverage their capital to increase profits when the market moves in their favor, and the primary risk and concern of margin trading is that losses will be correspondingly amplified if the market moves against the trader.