In this post today, What Is Buying on Margin will be explained to you in a very easy and better way, so let’s start.
There are two approaches to earning money from the stock market. The first is known as investing, and the second is trading. While both ways are meant to make money from the stock market, there are also some great differences between trading and investing.
One of such differences in trading and investing is requiring capital. By the sentence, we are certainly not intending to say that you don’t need any capital to trade in the stock market, but the need for capital and its amount is comparatively very low than what is required for investing.
Whenever we do trading in the stock market, it is not always necessary to have the proper amount of funds required to purchase any stock. Often, it is seen that traders do trade in the stock market with much capital, which they don’t even have.
So how do they get the capital? What is it? Whether you, as a normal trader, can get the capital? Whether Is it legal or not?
Understanding the Stock Market In Extremely Simple Words –
Now, let’s first understand The primary concepts of stock margin. We’re going to answer 3 common questions about Stock margin from which you can learn the very basics of the stock margin.
What Stock Margin Is?
In extremely simple words, the stock margin is the money of others.
What Buying on Stock Margin Is?
Purchasing any stock using the stock margin simply indicates that the particular stock has been purchased by borrowing someone’s money.
Who is the person who will lend you the money?
In all general cases, it is none but your broker who will lend you the money to buy stocks using stock margin. The idea of stock margin may sound great, but it is not that easy. To understand it deeply, keep reading the post till the end. To start with, We have to know the differences between a normal stock account, also known as a cash account, and a margin account.
Whenever you opt for making a new account at the platform of any online stockbroker, there appear 2 types of accounts to select from. The first one is what everyone chooses – a cash account, and the second one is the special one – a margin account.
A Cash Account
The first one is you really simple – a cash account. A cash account is just like any savings bank account where you can use all the money you have kept in your bank account anytime & anywhere. You will be allowed to use only the money you have already kept in your account, and the bank will not lend you any money for that matter.
So if you have $10000 in your bank account, you will be allowed to use the maximum amount of $10,000 (if there aren’t any certain restrictions.). In cash-account also, if you have a balance of $1000, you will be allowed to trade stocks or funds of just $ 1000.
Before talking about a margin account, we should know the reasons.
Why Would You Need a Margin Account?
Everybody enters the stock market with the hope of earning money. The chances of earning money are directly proportional to the amount of capital you have to trade. That’s where the concept of leverage comes off. In simple words, from the stock market view, leverage is just the expedition of your funds.
With a margin account, as you are getting more funds than what you actually have, you are certainly getting the opportunity to increase the amount of want you currently have using your broker’s money.
Unlike the cash account, a margin account is a type of account that allows the traders to trade using the broker’s capital. We use a simple matrix to see the effectiveness of any margin account. It is just the ratio of funds employed versus the amount of funds your broker lets you trade.
Let’sLet’s assume that to be 2:1. You will get 2x funds of what you have put in your margin account in this certain condition. If you do have $ 100 in your margin account, your broker will lend you another $ 100, and altogether you will get $200 to trade instead of $100.
And for your information, the $200 amount is now your buying power. The higher the antecedent of the ratio is, the more money you will get to trade.
Generally, the ratio, which is also called the margin rate, is not that low in the case of the stock market. It tends to remain between 5% to even 12% in some cases. But in the case of Forex, the scenario totally changes, and this ratio becomes 25:1 or even 50:1, which means that for every $1 in your trading account, you can trade the amount of $ 50.
So while using any broker, you can see the documentation about margins from where you can get an overall idea about what margin rates they are offering.
Short Selling – One of The Best Benefits of Having a Margin Account
We generally buy stocks first and then sell them off when the stock price reaches high. But if you, with your technical analysis is, predict that the stock price of a certain stock is going to be down in the upcoming days, there is a feature in the stock market called short selling with which you can sell the stock at a much higher price.
And when the price of the stock goes down, you can purchase them again. This widget is called short selling, which allows you to sell stocks before purchasing them. With a margin account, you can do short selling.
What Is a Margin Call?
A margin call is another disadvantage of having a margin account. One of these is a sudden call/notice from your broker. The notice is given on the side of your broker when the value of your investment in certain areas has undergone the threshold of the marginal value of your broker.
In this case, you have to add some money to your broker’s margin account again. If you don’t do that within a certain time and credit limit, your broker may sell some of the stocks which are declining by their price really fast and violating the rules.
Risk of having a margin account:
Buying on Margin: What Is Buying on Margin?
- While there are endless advantages of having a merchant account that has certain disadvantages too of having it.
- There are certain charges for having a margin account. in most cases, the annual maintenance charge of a margin account is greater than that of a cash account.
- Most of the popular brokerage firms will only permit you a margin account when you have a big amount of money in your brokerage wallet.
A margin account lets you trade in stocks or other services like Forex with 3x, 5x, 10x amounts of funds you have. In general, it may seem that this feature is allowing you to increase your wealth by 3x, 5x, 10x. But if there are fluctuations
that disobey your prediction about the stock price, you may even face the loss instead of making any profit. That’s why it becomes really risky to trade with high margin rates, especially if you are a beginner and starting with very low capital.
I explain simply, trading with a margin account lets your earn 3x or 5x time more than what you were supposed to earn without a margin account but it also increases the chances of losing money by 3x or 5x times.
Margin Account or Cash Account, Which is Good For Me?
Whenever you open an account in any brokerage firm, they will ask you to select the account type you will need. A margin account or a simple cash account. Now the question is – which between those accounts is good for you?
The simple answer to this question is that if you are an investor And planning to invest your money in a particular stock for at least 6 months, you don’t need to open a margin account. But if you are a trader and willing to deal in the derivatives market, you should opt for a margin account.
So this was our article on margin account and buying stocks on margin. In this article, we have tried our best to use simple and Call upon the words for readers to understand the topic clearly. We want more readers to understand each and every topic of Finance in an extensively simple way – so that everyone can trade or invest in the stock market with the hope to grow their wealth.