Margin Account Concept In Trading
Margin Account-An intermediary account for margin trading that allows clients to buy securities by borrowing funds from brokers. Margin account loans are backed by stocks. If the value of the stock drops significantly, the account holder will need to add cash or sell a portion of the stock.
A margin account gives you extra options that you may or may not choose to use. Margins are still synonymous with risk for many traders, but the truth is that risk is mainly if we do not understand how it works. As such, a margin account does not inherently increase the risk. It gives us, however, the tools to increase our risk over any period of time and thus be able to achieve higher profits. Below, you will find out what a margin account is and why it might be interesting for you. You should also be aware of some of the risks associated with using a margin account.
Below you’ll see what the margin account will allow you, why it might be interesting for you, and what the risks are associated with using a margin account.
1) Speculation on the decline
Just like when you buy assets and then sell them higher, you can first sell the assets and then buy them lower and make a profit. It must be said that the situation may be the opposite and you will realize a loss.
What I mention is so-called short-selling and it is definitely not a safer way to make a profit, it is just a way to implement more business ideas.
In short-selling, you borrow shares from other investors. They will reward them for you, but they will not lend them and you will pay them interest on their value for the duration of the transaction. It varies according to the individual event and its current annual value can be viewed at any time in the trading platform.
Please be aware that in short-selling your potential risk is greater than when buying shares. This is because when the stock is bought, the stock may go to the lowest value of 0, but when selling, its potential growth is not theoretically limited.
2) No need to wait for settlement
The cash account is settled in so-called settlement. This is the time lag between when you execute the trade and the actual crediting of assets / cash to your account. The time required after selling a share position to complete a purchase is typically two days. Likewise, if I exchange funds in another currency, it is necessary to wait 2 days by default before I can use the purchased currency. This does not apply to a margin account. The broker allows you to buy new positions even if your funds have not yet cleared.
why is that? Two days is the standard time for a purchase or sale. When I sell stock A and immediately buy stock B, the transaction will be settled in my account in two days. When there are two transactions that take place in a day on the same account, there won’t be any interest charged. It will only be charged if I bought an asset with a shorter settlement than the asset I sold.
If I don’t use money lending or the principle of financial leverage, then my margin account behaves like I do in a cash account:
Market risk does not increase.
I don’t pay interest.
I’m not in danger of a margin call.
I can use the option to use funds immediately without waiting for settlement.
I have options available to benefit from market situations from which I could not benefit from a cash account .
3) Currency hedging
When you purchase foreign assets in a currency other than your own, you can borrow the purchase amount in a foreign currency. Currency hedging allows a company to exchange one currency for another in order to minimize risk.
Borrowing a foreign currency for a transaction means that the value of the transaction is not exposed to the currency risk -> what you borrow, you will return to it -> the profit/loss from the transaction will remain only in the foreign currency.
Borrowing in foreign currency will occur automatically if you enter a purchase into your account in a currency that you do not currently have in your account (or borrow the part that you lost for the purchase). Likewise, the loan is repaid automatically after the sale up to the amount received from the sale. The result is a change in foreign currency only through the realized profit or loss.
Briefly currency hedging allow several things:
-Protect trade profits from potential devaluation due to currency movements
-Manage currency risk at any time
-Borrow foreign currency for transactions without the need for currency conversion
During the rental period you pay interest for the rental according to the currency (rates here ). You can currently borrow the US dollar for 5.9% pa, if you hold the position for a whole month, you will pay 0.5% of the value of the position.
Your purchased shares rose 5% in a month, but the US dollar depreciated against your home currency by 5%. So by default you would have no profit. If you have secured the deal, you will pay 0.5% interest, but you will still have a profit of 4.5%.
– You can repay the loan at any time during the transaction by purchasing the borrowed foreign currency in your home currency. In this case, your currency risk will be restored at that moment, as you will receive the full value of the position in a foreign currency after the sale.
– If, for whatever reason, you repay the loan on the same business day, you will not pay interest. Interest is charged only when held overnight.
4) Leverage is available
Leverage allows you to create a larger position than you could afford with your own resources. You will pay interest on the holdings from the funds you borrow in this way.
For example, if you create a position twice as large as your funds, you can realize twice as much profit or loss with the same market movement.
How does leverage work?
In principle, this is the ratio between how big my exposure is and how much I have my own funds.
I have $ 10,000 and I buy shares for $ 8,000 in my margin account. Although my margin is blocked on my account, I do not trade on leverage, because first my own funds will be used, which are fully sufficient to cover the purchase. I will not pay interest and I am not at risk of margin call , because I can lose a maximum of 8000 USD, which is not more than the value of my account.
I have $ 10,000 and I buy shares for $ 15,000 in my margin account. In this case, $ 10,000 is used first and then $ 5,000 is borrowed. I will only pay interest on borrowed $ 5,000. The risk of margin call is here because you can theoretically lose more than you have your own funds.
If the stock is trading at 50% margin, the margin will be $ 7,500. So margin call will start coming as soon as the loss is 2500 USD or more.
* From a risk perspective, be aware that if you hold a position that is more valuable than your own funds, its value may drop by more than you have and your account may end up minus leverage and movement.
This is a scenario that should normally be prevented by the so-called margin call, when we close your position long before it happens, but sometimes it may not be possible. For example, if the movement is really fast and significant or you hold a position outside business hours, broker may not be able to close your position.
First of all, please use the demo account and consider the margin account only after thoroughly testing its mechanisms and understanding all possible risks mentioned in the article, but also in the documentation on our website.
Last Important Information
We strongly discourage using a margin account and applying for it if you have no experience with margins .