What exactly is Margin? Is it risky? Should you trade with a margin account?
So we’re going to dive into the details of what exactly is margin in day trading,
the pros and cons of using a marginal account, and of course, how to use margin to your advantage
to grow your accounts exponentially.
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bad jokes. Seriously, be careful what you wish for.
Before we proceed, here’s a brief explanation of what it means to day-trade with a margin
account vs a cash account.
If we’re using a regular cash account as most conventional investment accounts to trade.
Let’s say you have a $5000 small cash account.
So for example, if tesla is at $340 right now, normally if I'm buying in cash 5K , I
could only buy 14 shares of tesla. And If I sell my shares at $360. I make $20 a share.
On 14 shares thats $280 with a cash $5000 account. Not bad right?
Now what if i'm trading the same $5000 in a margin account? Margin trading allows you
to borrow funds from your broker, hence increase your buying power in order to purchase more
shares than if you were just using your own $5000 in cash. So instead of just $5000 buying
power, I now could use up to $20000 of buying power if im using margin.
So if im day trading with margin in this case. If I buy tesla stock with the intention of
buying for the dip here and selling it for a quick bounce, I could buy double the amount
of shares of TSLA. since my broker allows me 4:1 leverage when trading on a margin account.
So if I sell my Tesla for a bounce of 20 points. Then I made $20/ share. On 30 shares that's
$600 return, only using my own $5k of capital. This is just an example
And this is the biggest pro of trading on a margin account. By using leverage properly,
margin accounts lets you amplify your potential returns - as well as your losses, which is
very important and we’ll go over that in just a little bit.
When you use margin, you are borrowing money from your broker to finance part of your trade.
Most brokers will give you 3 to 1, 4 to one margin, or sometimes 6:1 buying power when
day trading intraday. So with the same $5000 capital, I could get up to 15K, 20K or even
30K worth of buying power.
However, when holding positions overnight, the buying power drops to 2:1. So maximum
10K of buying power.
So thats the first pro of trading on margin. Now the second pro of trading with a margin
account is the trade settlement periods.
If you’re using a cash account to day trade, the capital you use into these positions,
the cash will take 2 days before it comes back to your account so you could trade again.
So in our example earlier on the TSLA trade. If I bought 14 shares of TSLA. and made that
$280 profit, I would have to wait 2 days for that $5040 cash to return to. 4760 was my
original capital, and 280 was the profit from the trade.
So in other words, I only have $240 left in my cash account for the next two days. I essentially
cant trade until that cash settles. It's very important to wait 2 days. Trust me you don't
want to experience violations and risk your broker locking your account for 90 days. It's
the same as violating the PDT rule.
But with a margin trading account ,you do not have to wait for the cash to settle before
reusing that capital again. And this my friends, is extremely beneficial. Especially if you
want to become a full time day trader. There's different opportunities in the market every
single day. I dont want to have to wait 2 days to trade again.
So in our example earlier, once I'm closed out of my TSLA long trade earlier, while the
profits of $600 will not come in until the next trading day. I could reuse my original
$5000 capital, and then 20,000 buying power, the same day.
Now the third pro of using a margin account… I know you’re going like, Hol' up there's
more? Yeah! I kept the best and biggest pro for the last point, and this is none other
than the popular short-selling.
Even if you don't need the extra leverage in buying power, or you don't care about the
cash settlement period because you’re trading part time anyways, having the ability to short
sell just opens so many opportunities to profit in the stock market, whether the market is
going to the moon or crashing to the ground.
A margin account allows you to short sell and profit from the falling stock prices.
With short-selling, you can borrow shares of stock from your brokerage firm, sell the
shares, and buy them back at a lower price. Your profit is the difference between the
proceeds of the original sale minus the amount required to buy back the shares. You cannot
short with a cash account.
Despite all these benefits or pros, day trading with a margin account is not for the faint-hearted…
Thats why its important to understand what margin trading really iis, and what the pros
and cons are, so you can decide for yourself. And most importantly, until you’ve taken
risk management seriously Why am I saying this? Margin accounts come
with higher risks than cash accounts. Since you are not only trading with your funds,
you are also trading with your broker’s funds. If you start gambling with your entire
buying power. Chasing the high of the day breaks and following chat room alerts, not
only do you risk your original $5K capita, you could also owe your broker a lot of money.
Ok serious talk here. Whether you’re new or experienced trader. This is very important
to understand. When using margin to day trade, you must be
aware of the margin maintenance for your account. Margin maintenance is the amount of capital
you need in order to keep your trading position open.
For example, if a trader borrowed the broker's money to buy 30 shares of TESLA at $340, he
or she would borrow $5200, plus 5000 of his own capital. The total valuable of position
is $10,200. And the margin maintenance in this case would be 50%.
Since he owns 5000 of capital. If his broker has a minimum margin maintenance of 30%. This
stock position is perfectly fine right now because his maintenance of 50% is above 30%..
Now god forbid if that same day, Elon Musk is bored outta his mind in the office, and
he decides to tweet. TSLA stock is too high right now IMO.
And TSLA stock drops to $240. That means the value of this traders long position is now
only 7200. But remember, the trader borrowed $5200 earlier from my broker, since he used
margin to purchase this TSLA stock position. This is where the trader would be threading
which now 7200 minus the amount he loaned from his broker, the 5200, the amount thats
actually belongs to the trader is now down to $2000, from his original 5000 capital.
2000 remaining is only 27.77% of margin maintenance. And remember, since our margin maintenance
mentioned earlier was 30%, and the current valuation of his long position on TSLA is
now from 10200 to 7200, the trader must keep at least 2160 in the trading account in order
to keep this position open. Since the stock position has now fell under
30% margin maintenance, this is when you’ll get an important phone call. No its not the
guy or girl you’re dating calling you to tell you how much they miss you or love you.
I mean, i wouldnt know what thats like. No, this is even worst than mike bagholder
calling me again, this is what we call margin call. A margin call is not a actual phone
call nowadays. Maybe it used to be, but even the brokers are too lazy to pick up the phoen
and dial now. Usually its an email or text alert sent to
your phone from your broker demanding that you fund additional capital so your position
keeps above 30% maintenance. To respond to the margin call, In this case,
the trader in our example could 1) either fund at least additional $160 to his account,
to stay above 30% margin maintenance. 2. Sell part of the stock position for a loss.
But the equity released would reduce the amount he or she is borrowing from the broker.
Or number 3, If the trader does not act fast to respond to the margin call, the broker
may liquidate the entire position. Without further notifications. Liquidation ensures
that the broker will get their original 5200 loan back, i mean, they gotta protect their
ass right?so they want to make sure their capital is safe, and some of yours too…
maybe
So if the TSLA long position in our example gets liquidated at $240. That means the trader
would take a loss of $100/ share. On 30 shares thats a realized $3000 loss. Basically this
is a 60% haircut of that original 5000 account.
Like i mentioned earlier, while using margin account gives you 4:1 or greater leverage
buying power, it also increases your risk. And thats why I have the following tips for
you if you decide to use a margin trading account.
Number 1, do not over leverage. Do not use your full buying power. If I have 50K in my
account, that means i have up to 200K worth of buying power. I never use all of it. Just
because you could, doesn’t mean you should.
And f you’re new to trading, and your capital in the margin account is only $5000. Only
trade with that 5000. So for that example, you should only buy up to 14 shares of TSLA.
You could keep margin account so you get the ability to short sell, and also have the funds
settle in within the same day.
Number 2, follow your stops. The trader in our example earlier is basically mike bagholder.
He didnt follow his stop. A proper trading plan should include entry, profit target,
and most importantly, a stop. So you can prevent one losing position from blowing up the entire
account like we talked about.
So, back to the question, “should I day trade with a margin account?” Well, I will
tell you this; Margin accounts are extremely beneficial for professional traders who use
them to maximize profits both on the long side and short side. When used correctly,
you can fully maximize your buying power and take advantage of the market volatility.
But when used incorrectly, or if the trader disregard risk management , you can lose their
entire investment due to a margin call. Again, Your account type is just a tool of
business in day trading, whether margin or cash, will not determine your success or failure
in trading. There's a lot of misconceptions online about margin. Margin has a bad rep
because all the people say its gambling or it’ll be the reason you blow up.
Let me reassure you, Margin, by itself, is not the reason traders fail or blow up, its
the trader’s own lack of risk management or lack of discipline, or following chat room
alerts at the HOD breakdouts, thats doing the damage.
And truth be told, a reckless trader can blow up both margin and cash accounts, so blowups
are not limited to margin my friends.