Margin trading
Margin trading makes it easier for traders to enter into trading opportunities as you don't have to worry about spending a lot of cash to acquire an asset.
Margin is the interest owed on loans between you and your broker in relation to the assets of your portfolio. For example, if you short sell shares, you must first borrow it on margin and then sell it to the buyer. Or, if you buy on margin, you will be offered the ability to leverage your money to buy more shares than the cash you spend.
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For example, with a margin of 10%, you can buy up to $ 1,000 worth of shares with only $ 100 subtracting. You are given an additional $ 900 in the form of a marginal loan, on which you will have to pay interest. If you have a margin account, it is important that you understand how this margin interest is calculated and be able to calculate it yourself manually when needed. It is just as important as the interest on your savings account.
Before making a calculation, you must first know the margin interest rate your broker charges for borrowing money. The mediator should be able to answer this question. Alternatively, the company's website may be a valuable source for this information, as well as account confirmation and / or monthly and quarterly account statements.
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Usually the broker will list their margin rates alongside other disclosures of fees and costs. Often times, the margin interest rate depends on the number of assets you have with your broker, the more money you have with them, the lower the margin interest you are responsible for paying.
Margin interest calculation
Once you know the margin interest rate being charged, grab a pencil, piece of paper, and calculator and you'll be ready to find out the total cost of the margin interest payable. Here's a hypothetical example:
Let's say you want to borrow $ 30,000 to buy a stock that you intend to hold for 10 days where the interest margin is 6% per annum.
In order to calculate the cost of borrowing, first, take the amount of money borrowed and multiply it by the rate charged:
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$ 30,000 x .06 (6%) = $ 1,800
Then take the resulting number and divide it by the number of days of the year. Typically, the brokerage industry uses 360 days, not the anticipated 365 days.
$ 1,800 / $ 360 = 5
Next, multiply that number by the total number of days you've borrowed, or expect to borrow money on margin:
5 x 10 = $ 50
Using this example, it would cost you $ 50 in margin interest to borrow $ 30,000 for 10 days.
While margin can be used to amplify profits in the event that the stock rises and a leveraged purchase is made, losses can also be amplified if the price of your investment falls, resulting in a margin call, or the need to add more cash to your account to cover those paper losses.
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Remember that whether you win or lose on a trade, you still owe the same margin interest that was charged in the original transaction.
The bottom line
Margin trading is a risky business, but it can be profitable if managed properly and, most importantly, if the trader does not get over himself. It also makes accessing specific asset values easier as the trader does not need to pay the total cost of the asset when he sees an interesting trading opportunity. When entering into a margin trade, it is important to calculate the cost of borrowing in order to determine the true cost of the deal, which will accurately indicate profit or loss.
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