Takeaways:

• You can trade on margin if you have $2,000 of net assets in your account.
• A margin account gives you additional buying power to buy or short securities. This could amplify your profits or losses.
• If the equity value in your account is $25,000, you can make unlimited day trades.
• You may trigger margin calls during margin trading.

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What is margin trading?

Margin trading means borrowing money or securities from your broker to trade, using the assets in your account as collateral. In other words, it allows you to leverage what you already own to purchase additional securities or short sell securities. Just like in a loan, you need to pay interest on the money or securities you borrow.

If you have $2,000 of net assets in your account, you can trade on margin.

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What can you do with a margin account?

In a cash account, you can only use your own deposit to trade. In contrast, a margin account gives you additional buying power based on your account value, with which you can buy or short securities.

When an investor is bullish towards a security, he may use his additional buying power to buy more shares.

Suppose Jack believes Stock A will surge in two weeks, and he has $5,000 in his margin account. To increase his profits, he borrows another $5,000 from the broker and makes a total investment of $10,000 in Stock A (at $20 per share).

If Stock A surges to $25 as Jack expected, his returns could be $2,500. In this case, his returns are doubled compared with buying in a cash account. However, if the stock tumbles to $15, his losses are also doubled.

When an investor is bearish towards a security, he may short a security.

Unlike Jack, Jane decides to sell short 500 shares of Stock A (also at $20 per share).

If Jane is right and the stock drops to $15 a week later, she can close her short position by buying the shares back at $15. Her returns would be $2,500.

However, if Jane waits for a week, and the stock climbs up all the way to $25, she would have to buy back the shares at $25 per share to stop losses. Her losses would be $2,500.

*Note: Margin interest is not included in the calculation of profit/losses of the above two examples.

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What are the rules for margin trading?

While margin trading provides more trading opportunities, understanding the rules and potential risks is essential before you start.

If you like to day trade, you probably want to keep your equity value above $25,000. This is because when you’re flagged as a Pattern Day Trader (PDT) and your equity value dips below $25,000, an Equity Maintenance (EM) call may occur.

Another important thing to understand is buying power. This determines how much you can spend. There are two types of buying power:

- Day Trade Buying Power (DTBP) refers to the funds you have available to place trades on a given trading day. It is often 4x your equity value.

- Overnight Buying Power (ONBP) refers to the funds you have available to hold positions overnight. It is often 2x of your equity value.

This means you cannot use all of your DTBP and hold the position overnight. You may trigger margin calls related to buying power. Read the rest of our course to learn more about margin calls.

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