Margin trading

Margin trading is when, typically US, investors put up only a percentage of the cost of an asset they buy. The balance is borrowed from a broker who charges interest on it and whose collateral is the value of the shares held in the account. This deposit (or ‘margin’) is held with a broker in what is known as a margin account. The minimum amount that must be held in the margin account is called the margin requirement. Margin accounts are common in the futures and derivatives markets, but are also used in the equity markets.

In rising markets, trading on margin works very well for investors, as it allows them to gain exposure to larger trades by value than they could otherwise (if you need only pay a margin of 10%, £1,000 can give you access to £10,000 of securities, for example). Profits are then highly leveraged. However, as the asset bought on margin is the broker’s collateral, if its value starts to decline he will want to reduce the value of the loan outstanding. He will then demand extra money. This demand is known as a ‘margin call’.

Note, too, that losses are as leveraged as gains. If you put down £1,000 on £10,000 of stocks and the share price falls 10%, you will have lost all of your money.

Merryn

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