While there is some risk, the benefits of margin trading can outweigh the hazards. It’s a familiar tool for many investors. Because when used properly, it can offer a substantial boost to an active trader’s portfolio.
Margin trading gives access to additional investible capital. It’s essentially a line of credit – or loan – from a brokerage. It operates similarly to a home equity loan. Except in this case, instead of using the equity of a home as collateral, you can use cash or securities as collateral.
The amount of a home loan is determined by the value of the property. And how much margin a brokerage is willing to offer is based on the value of investment holdings and cash in the account.
So why would anyone invest with borrowed money? For the same reason someone would take out a home equity loan for a home improvement project.
Let’s say someone takes out a home equity loan of $15,000 to update the kitchen. Those new quartz countertops, fancy stainless steel appliances and custom cabinets could add a lot more to value to the home when it’s time to sell. In this case, a home loan makes perfect sense.
If the home equity loan was used to buy a new car that instantly depreciates, that’s a bad use of it. Same goes for using it to fund a vacation or pay for college. You’re more than likely to never see a return on investment in these cases.
So like a home equity loan, the benefits of margin trading depend on what you do with it. If an investor uses a margin loan to willy-nilly invest in volatile stocks, they’re gonna have a bad time. Margin is best used on proven investment strategies.
How to Reap the Benefits of Margin Trading
First off, trading on margin can be treacherous. It can wind up costing an inexperienced investor even more than they have in their account. If margin is used to buy stocks or securities that plummet in price, the brokerage can issue a margin call. This results in a fire sale of any holdings in the account. And if the brokerage isn’t able to recoup the costs of margin lent from this liquidation of assets, the borrower is still on the hook for outstanding debts.
This is why in the wrong hands margin can be disastrous. But – and this is a big but – when margin is properly harnessed it can lead to increased gains and a turbocharged portfolio. You just have to be aware of the possible pitfalls. Here are four valuable keys to benefitting from margin trading.
Keep It Quick
Just like any other loan, margin accrues interest over time. On the road to financial freedom, it’s imperative to pay off most debts as fast as possible. So keep those trades on margin reserved for strategies with brief timelines. This isn’t appropriate for a “set it and forget it” investment. Margin is best used in the …read more
Source:: Investment You