Buying stocks on margin is not something new; people have been doing it for a long time. Just before the great depression in the 1930s, investors were allowed to buy stocks with just 10% margin (meaning you put in $1,000 if you wanted exposure of $10,000). That was one of the major reasons why the economy went out of whack during that time. People borrowed too much and were forced to sell their positions due to margin calls, which forced the prices down.
Investing in the stock market on margin shouldn’t feel strange because you probably bought your house and car on margin; it’s essentially the same thing. Using credit to buy and sell things at a faster pace is one of the foundation stones of our modern world (most of it anyway). It is in a lot of ways a natural thing, but that doesn’t make it non-risky. It’s like driving cars. It feels natural but is still the riskiest thing most people do in their day-to-day life
Understanding Margin
Investing on margin is not as lenient as it used to be. You will need to pay up at least 30% of what you intend to buy (30% of market value). If you intend to take a position in something that is considered risky you might have to put in more (say 100% for pink sheets). If you want to short-sell you might have to put up 150% or more as margin. Since short-selling is riskier than long transactions, margin numbers are significantly higher. For example, if you are short-selling stocks worth $1,000, you will probably need to have at least $1,500 in your account at that time.
In addition to the initial margin there is something called a “maintenance margin” that you will need to keep as long as you hold the position. If your position loses, say, $5,000 and your broker allows 50% maintenance margin at all times, you need to put in an extra $2,500 cash to make up for it. You could use stocks as margin too but not all stocks are rated equally and hence not valued at 100% of their market value (like cash is). Organizations like FINRA in the U.S. or the IIROC in Canada set out the limit of maximum margin allowed. Brokers may be a little more conservative than what is required.
Leveraged Instrument vs. Leveraging Using Margin
Buying anything on margin (or loan) doesn’t come for free. The broker charges you interest on the money they lent you for transactions. It could be 4-7% (or even higher) depending on prevailing interest rates and your account balance. Imagine you held a position for a month and lost $300 on a transaction worth $10,000. If your broker lent you $5,000 and charged you 6% interest, you paid $30 in interest for the year (plus other commissions and fees). So that is an extra cost on top of what you lost.
If, however, the instrument itself is leveraged (like a leveraged ETF) you don’t need a margin account to trade them. Of course there is a management fees (usually less than 1%) but that’s much lower than the interest you pay on a margin account. Leveraged ETFs have only been around for the last ten years or so and investors may not be as aware of them. You get to invest in a self-diversified instrument (say a broad or sectorial index) and pay low fees while doing that.
The Bottom Line
Buying anything on margin (or loan) doesn’t come for free. The broker charges you interest on the money they lent you for transactions. It could be 4-7% (or even higher) depending on prevailing interest rates and your account balance. Imagine you held a position for a month and lost $300 on a transaction worth $10,000. If your broker lent you $5,000 and charged you 6% interest, you paid $30 in interest for the year (plus other commissions and fees). So that is an extra cost on top of what you lost.
If, however, the instrument itself is leveraged (like a leveraged ETF) you don’t need a margin account to trade them. Of course there is a management fees (usually less than 1%) but that’s much lower than the interest you pay on a margin account. Leveraged ETFs have only been around for the last ten years or so and investors may not be as aware of them. You get to invest in a self-diversified instrument (say a broad or sectorial index) and pay low fees while doing that.
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