Margin Trading

Point to consider: Investing using borrowed money is NOT a good idea!!

We heard and read a lot about margin trading these days. These days, unfortunately, it often blamed or related to a drop in share prices. The recent Allco Finance Group's drop in share price because of their excecutives failed to fulfil margin call was one of thye example, and so was the Tricom (broker) fallout.

Although not lucky enough to escape from the carnage in the ASX, I felt quite lucky that I own all my shares. They all are bought in cash with my own money, and that way, I have full control of my stocks.

What is Margin Trading?

Reading from some source, basically there are two ways to purchase stocks:

1. The buyer can pay the purchase price in full
2. Using a margin account.

In a margin account purchase, the buyer pays a portion of the purchase price and the broker lends the difference. The buyer in turn pays interest on the broker’s loan in addition to the usual commission fees. For collateral, the broker holds onto the stocks.

Margin is a high-risk strategy that can give you a big profit if executed correctly. The negative side side of margin is that you can lose a lot more than your initial investment.

Investopedia wrote that buying on margin is borrowing money from a broker to purchase stock. This way, margin trading allows you to buy more stock than you'd be able to normally.

Buying on margin is mainly used for short-term investments, because borrowing money isn't without its costs. You have to pay the interest on your loan. The interest charges are applied to your account unless you decide to make payments.

And What is Margin Call?

You would receive a margin call from a broker if one or more of the securities you had bought (with borrowed money) decreased in value past a certain point. You would be forced either to deposit more money in the account or to sell off some of your assets.

If for any reason you do not meet a margin call, the brokerage has the right to sell your securities to increase your account equity until you are above the maintenance margin. Even scarier is the fact that your broker may not be required to consult you before selling! Under most margin agreements, a firm can sell your securities without waiting for you to meet the margin call. You can't even control which stock is sold to cover the margin call.

Source: investopedia and other sources.