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What is Margin Trading?

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If you’re a trader, you know that trading on margin fuels some incredible money-making opportunities. On the other hand, if you’re a beginning trader, the prospect of trading on margin could scare the pants off of you, or your reaction could be completely the opposite. It could cultivate a burgeoning excitement or curiosity.

While everyone’s initial response and ensuing experience are different, there are some commonalities that everyone who trades on margin experiences.

What is margin trading?

When you buy on margin, you borrow from a broker to purchase stock using a special margin account with that particular broker. Buying on margin allows you to purchase more stock than what you’d otherwise be able to buy with just the funds in your account. Ultimately, doing so ramps up your buying power.

If you’ve read a little bit about margin trading, you might see another word bandied about, and that word is “leverage”. Note that margin is not leverage. In fact, margin allows you to leverage the funds in your account to enter larger trades. Leverage is expressed as a ratio. A 3:1 leverage, for example, means that you would be able to hold a position that is three times the value of the amount in your trading account.

How does margin work?

Individual brokerage firms will offer you a list of accounts that are marginable. Most brokers require at least $2,000 in equity in order to access margin through that particular broker.

How does margin work, anyway? Fidelity’s website offers a great example of how margin specifically works:

How margin trading works. Source: Fidelity.com
How margin trading works. Source: Fidelity.com

Obviously, stock prices could drop when you’re trading on margin, too, and here’s a great illustration of how that can impact your account on TD Ameritrade’s website:

Source: TDAmeritrade.com
Source: TDAmeritrade.com

Pros and cons of margin trading

As with any type of trading you’ll do, there are pros and cons, but margin trading could offer a heightened nail-biting scenario if not done correctly.

Pros, or benefits, include:

  • The most positive benefit to trading on margin is the maximized potential returns because of leverage.
  • More trades are available and offer more diversification because of the amount of buying power you have while trading on margin.
  • You can employ more advanced strategies.
  • You have more trading flexibility.
  • Interest on margin loans could be tax deductible against your net investment income.

Cons, or risks, include:

  • It’s inherently risky to trade on margin, and you could lose your initial investment, plus what you borrowed.
  • Trading on margin involves additional costs through the broker in the form of interest on your loan.

How to manage risk

Trading on margin isn’t for everyone. It’s important to carefully evaluate your risk tolerance and ability to trade on margin based on your financial resources.

The prospect of losing money through leverage is a major risk, as previously discussed. Maintenance call risk is another type of risk, and what happens when your account’s securities fall below the minimum maintenance requirement. Margin calls are required to be paid immediately, so it’s imperative that you leave a cash cushion in your account to reduce the risk of a margin call.

In addition, the more research you can do to try to minimize risk on your account, the better off you’ll be. Thoroughly research the securities you’re considering.

Where to start margin trading

Most major brokerages offer some form of margin trading – even some of Benzinga’s picks for the Best Online Brokerages. Here’s a quick peek at some of our favorites.

Commissions
$0
Account Min
$0
Get started securely through Ally Investment’s website
Commissions
$0
Account Min
$0
1 Minute Review

Ally Invest is a comprehensive broker offering easy access to domestic markets. Combining a wide range of charting tools with an easy-to-master platform, Ally is a solid choice for both new and experienced investors. Ally’s mobile app is particularly impressive for investors who already bank with Ally, offering seamless compatibility between accounts. While more experienced investors might be disappointed with Ally’s beginner-oriented educational center, they’re bound to love Ally’s wide range of technical tools and rock-bottom pricing.

Best For
  • Investors who already bank with Ally and want to streamline between accounts
  • Beginners looking for easy-to-follow educational tools
  • Stock investors looking for affordable access to low-priced options and commission-free stock trading
Pros
  • Streamlined interface that’s easy to use and quick to master — even for beginners
  • Wide range of unique tools that makes analyzing securities simple
  • Seamless integration between mobile and desktop offerings, especially for Ally Bank account holders
  • Diversified managed investment portfolios with a low minimum and no advisory fees
  • Impressive ETF screening tools that make it easy to find your next fund
Cons
  • No fee-free mutual funds
  • No access to futures trading
Commissions
$0
Account Min
$0
Get started securely through eTrade’s website
Commissions
$0
Account Min
$0
1 Minute Review

E*TRADE is an online discount trading house that offers brokerage and banking services to individuals and businesses. One of the first brokers to embrace online trading, E*TRADE not only survived both the dot-com bubble and Recession — it thrived. You can choose from two different platforms (one basic, one advanced). E*TRADE is a suitable broker for traders of most skill levels, whether you want to buy mutual funds and hold them for decades or dabble in options swing trading. E*TRADE offers a library of research and education materials to help you out.

Best For
  • Active traders
  • Derivatives traders
  • Retirement savers
Pros
  • Sophisticated trading platforms
  • Wide range of tradable assets
  • Exceptional customer service
Cons
  • Limited currency trading
  • Higher margin rates than competitors
  • No paper trading on its standard platform
Commissions
$0 $6.95 for OTC Stocks
Account Min
$0
Get started securely through TD Ameritrade’s website
Commissions
$0 $6.95 for OTC Stocks
Account Min
$0
1 Minute Review

This publicly listed discount broker, which is in existence for over four decades, is service-intensive, offering intuitive and powerful investment tools. Especially, with equity investing, a flat fee is charged, with the firm claiming that it charges no trade minimum, no data fees, and no platform fees. Though it is pricier than many other discount brokers, what tilts the scales in its favor is its well-rounded service offerings and the quality and value it offers its clients.

Best For
  • Novice investors
  • Retirement savers
  • Day traders
Pros
  • World-class trading platforms
  • Detailed research reports and Education Center
  • Assets ranging from stocks and ETFs to derivatives like futures and options
Cons
  • Thinkorswim can be overwhelming to inexperienced traders
  • Derivatives trading more costly than some competitors
  • Expensive margin rates

Final thoughts

All brokerages have different margin rates, so learn all about interest rates for margin accounts at all the brokerages you’re considering or wherever you already have an account. You’ll also want to pay close attention to account minimums as not to incur any fees or barriers to trading. If you’ve done the research and can afford to take a risk, then margin trading may be right for you. 

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