Margin trading in stocks
For those that haven’t been scared out of the market by the recent year’s financial turmoil margin trading is still popular. If you look at it, margin trading in stocks, bonds, and in particular credit swaps, is probably one of the main reasons we are in this mess in the first place. For those that don’t know what margin trading is, here is a quick read on the topic.
Margin trading means that a bank or financial institution lends you money that you can use on top of your own equity. It functions like a mortgage, where you have equity Y and can buy a house for Y times Margin factor. As an example, you have $50.000 in equity and the bank is willing to lend you 3 times this amount. You can then buy a house for $50.000 x 3 = $150.000.
It works the same for margin trading, with some key differences. The institution lending you money places a factor on each individual stock, usually from 0 to 5. The riskiest stocks sometime have a factor of 0, meaning they won’t lend you anything for this stock. The least risky might have a factor of 5, which means that with equity of $10.000 you can buy stock for $50.000. Usually the factor is notated as a percentage of price, meaning that if a stock can be leveraged by 80%, you only need 20% equity.
The main difference between a mortgage and margin trading, or margin accounts, is that your friendly bank can turn unfriendly in a matter of days, lowering the margin factor and meaning you might be underwater. You see, at all times you have to have money in your account to make up for the equity ratio. If a stock falls in price you will have to add more money, always maintaining the lower limit. And unlike mortgages, the bank will step in a sell your stocks for you, if you don’t keep up the equity limit. This makes margin trading extremely risky, and something you generally should stay away from.
Tags: bonds, equity, Margin trading, Stock Market, stocks
Recently Announced Articles
No Comments
No comments yet.
Sorry, the comment form is closed at this time.