What is Margin
In simple terms, ?Margin? is using money borrowed from your broker to buy stocks. A ?Margin Account? is a brokerage account that allows traders and investors to further buy stocks by credit a part of the cost. An investor normally use the edge to make use of their buying power, so that they can own extra stocks for investment without paying for them in complete. While this does increase the potential for greater earnings, margin trading also reveals traders to more danger and the likelihood of higher losses.
Outright purchase vs. borrowed funds
There are two ways in investing in stocks. The investor can pay for the buy in complete, or borrow from the broker or from financial institution.? In a borrowed or margin account, the investor pays a part of the cost and the agent/broker gives the balance. The investor then has to pay interest on the borrowed fund, in addition to the normal interest and commission charges. The agent maintains the stocks for security, and any earnings gained from the stocks are used to help balanced out the charges.
How margin trading moves
Assume that you purchased some stock for $40 each, and after three weeks the value rise to $60 each. If you purchased the stock in? cash out of your own and paid in full, you made a 50% return on your investment less any broker charges and revenue expenses. However, if you purchased the stock by investing $20 of your own resources and $20 borrowed from your broker/agent as margin, you would make a return of 100% on your investment, though you would still owe your agent $20 per stock plus interest and expenses.
Advantage and disadvantage
It is important for investors to understand the drawbacks as well as the key benefits of using margin. The same ?margin? that can outcome in much amount of profits can also cause to huge losses.
The main disadvantage of using margin becomes clear if the stock price drops fast cost failures can add up very easily. Let?s look returning to the example above. If the stocks you purchased in a cash consideration for $40 each decreased to $20, you would cut 50% of your own contribution. You? would loose 100 percent had you used margin to buy them, and still owe the expenses and interest on the borrowed money.
There is also the likelihood of a ?margin call? if the price of your stocks fall too low. This comes by the way of? asking your agent for more cash to put into your account maintained with the broker. Many new investors amazed to find that their agent has the right to offer any stocks that purchased on margin without any caution and possibly at a much loss. If an agent sells your stocks after the cost has delved, then you?ve missing out on the opportunity to extract your failures if the market moves up.
Conclusions
Margin works as an assurance that you will be able to satisfy the debts for the deals you decide to get into. While the extra money provides investors an opportunity to ?lean into? good deals, if you use up your unwanted margin and your roles shift unfavorably, you required to down payment more cash into your account to keep your status right. To prevent this scenario, all investors should use a Risk management control strategy to restrict their failures on investment.
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