Do you want to understand What is a margin buy? This comprehensive guide explains the concept, risks, and benefits of margin buying for beginners.
Introduction
Have you ever wondered, What is a margin buy? It’s a process where one company acquires another company to combine their operations and resources.
Many people have gathered enough courage and
knowledge to enter the stock market
and indulge in stock trading by
investing money wisely in good-performing stocks. Many-a-time, people start investing
in small amounts in balanced stocks to minimize the loss in the returns of
investment (ROI). Due to the paucity of time, many people sublet or delegate
the tasks of following different stocks to the fund managers to suggest when to
withdraw money after closing the stocks and re-investing afresh in
high-performing assets to maximize the gains in trading. People into stock and
securities trading have various ways of maximizing the returns, such as buying
the diverse stocks to put a cap on
the loss, margin buy, etc.
Also Read
- Understanding Trading Values: A Beginner’s Guide
- 10 Stocks to Trade Options for Maximum Profit
- Definition of a Day Trade: A Beginner’s Guide
Margin
Buy Option
Of the various investor options available, here we
will be dealing with the stock trading
with the margin buy option that
doubles the return of money if invested in high-performing or high-value
yielding stocks in the trading market for the sake of investors. So, do you want to understand What is a margin buy? This comprehensive guide explains the concept, risks,
and benefits of margin buying for beginners. Dive into the depth of the
concept.
What is a margin buy?
Buying on margin
involves securing a loan from the brokerage
and use its money to invest in more
securities than what one can buy using cash. The margin buying enables the investors to multiply their return of
investments, which happens only when the investments outperform the cost of
loan itself. In short, the margin buy
enhances the buying power for investors
to buy more shares to diversify the stocks in the market to minimize the loss
due to stock market fluctuations.
Hence, the margin trading uses
borrowed funds from a broker to trade on a finance asset, which is the
collateral for the loan from a broker.
For instance, if one invests $10,000 in a good stock
and gets a 20% return, he gets decent $2000 back as investment return. So, to
tap from same high-performing stocks
one needs more money to invest in. Thus, if one borrows another $10,000 from margin buying option, he would have
doubled the return by $4000. This is the plus point with the option of b.
Risks
Associated with Margin Buy
The margin buying is not free of risks. This
approach maximizes the gain when the stock
one bought is a good performing one. However, it may suffer due to unforeseen
events, which results in cumulative loss for the investor. The margin trading
would have resulted in immense gain when the markets recovered from pandemic
period initially. After the Federal agency raised the interest rates in the
subsequent years to combat inflation
in the market, the trading margin got reduced for an average investor to do the
borrowing to fund for new securities
available in the market. Higher the returns, the more is the available margin for the fund borrowing. This is
the reason why the investors may potentially lose money
faster when they find funds from margin
loans than relying on the hard cash. Not all securities can be traded with margin buying option. Hence, the margin
investing is usually allowed only for the professionals, such as managers
of mutual and hedge funds.
The
Benefits of Margin Buying
The margin
buying option gives the investors more buying power. The margin investment
allows them to have more assets to buy more marginable securities for
intelligent trading. The margin borrowed against the securities held in the margin account. The margin loans don’t
require approval or credit check by the bank. There is no set repayment
schedule for margin buying as long as one maintains the required equity in the
account. This is especially beneficial for those needing short-term cash flow. However, the trader has to
pay interest to Vanguard Brokerage for the duration of the loan.
Margin borrowing is generally more cost-effective than other lending options
available.
How
to Calculate Margin Buy?
The margin
buy for a particular stock can be calculated by using simple calculation
logic to get the value instantaneously. The brokers calculate the margin buy to be earmarked for stock purchase
using only three parameters. They are the number of shares, the stock price,
and margin rate.
The number of shares of a company can be calculated easily by checking its stock market capitalization. Its number
of shares available in the market.
It can be obtained by dividing its stock market capitalization with its share price.
Stock
Price: It is the amount it
would take to buy one share in a
company of choice. It is important to note that its value is not fixed instead
it fluctuates depending on the market conditions. The stock price is likely to go high if the company is perceived to be
doing good and on strong foundation. On the other hand, the share price may
fall if the investors perceive some
trouble in its fundamentals.
3.
Margin
Rate: It is an interest
rate or premium that applies to the margin
accounts with a brokerage. The
margin accounts enable investors to buy securities
using borrowed money. The margin rate depends on the total amount one wants to borrow, and
the number of days one plans to keep his trade open.
Based on these parameters, it is easy to calculate
the initial margin buy as follows.
Initial Margin Buy = the total borrowable amount x
the number of days x margin rate
Tips
for Successful Margin Buying
One can increase the margin buying power and improve the profits one can gain with
cautious actions. Following are the expert tips to avail the margin trading facility successfully.
- Measure the Success Rate of a Trade:
It is prudent to note in mind that the leveraging of benefits of trading using
the margin buys carry higher risks than regular ones. It is always
good to do an elaborate and fool-proof analysis of margin trades before embarking on implementing it. One has to
invest wisely to increase the odds of success.
- Steer Away from Emotions:
One should do away with emotions while trading in stock market. The emotions can impact the trade decisions
negatively. By embarking on trading in a disciplined way armed with solid
information about the market condition, one can beat the emotions that
adversely affect his thinking capacity.
After a long thought out process and a detailed study, outline the plan
based on the knowledge of one’s risk profile and set parameters to take a
prudent stand on trading in the
market. This will help in making quick decisions while dealing with the intraday trading.
- Always Start Small:
It is better to start small instead of jumping completely into trading to test
water. The margin buy allows the
trader to take a leverage position while slowly increasing the profit chances.
This approach will ultimately prove successful to contain the losses incurred
when the market conditions are not that conducive. It is better to determine
one’s risk profile before start
using borrowed money.
- Avoid Margin Calls:
The brokers initially expect the
traders to maintain initial margin requirements. This cautious step is very
much necessary to maintain the minimum balance to repay the borrowed amount to
the broker. Otherwise, as a trader
you may end up facing the margin calls.
If the trader fails to meet the
margin call requirements and keep the deposit that is needed to repay the
amount, the broker has the right to liquidate his trading positions in the stock market to recover the fund, no
matter how much losses the trader might have incurred due to forced liquidation. Therefore, it is
good to maintain the minimum margin in his account at all times.
- Use Stop Loss:
It is inevitable to employ effective risk management strategies in trading
using the margin buy money, like
stop-loss. The stop-loss arrangement
for each trading undertaken can help the trader to minimize possible losses.
