Trading on margin is a way to leverage your results using borrowed money. This is a speculative practice that can boost your profits as well as losses. Margin trading is not recommended for beginner investors, as you need a strong trading strategy and risk management practices and skills.
Traders use margin to amplify their profits. On the flip side, losses are also amplified. Day traders make multiple trades per day. A bad streak of leveraged trades can wipe out accounts rather quickly.
There are differences between how much a trader can borrow from their broker. The Reg-T (Regulation T) rule allows day traders to borrow up to 4x of their money. That is on top of the minimum account equity requirement. We suggest you check with your broker on the exact limits and check your jurisdiction for any limitations.
For short-term traders, the risk is far less, than for longer-term trades. This is based on the fact that positions are closed overnight. Note that brokers might liquidate any leverage over the permitted, for overnight positions. This is called a margin call.
Margin and Pattern Day Traders vs. Non-pattern Day Traders
There are two types of day traders – Patter Day Traders and Non-Patter Day Traders. The rules and regulations differ for each.
Pattern day traders have higher margin requirements. I.E. you have to deposit more money into your account. You have to have a minimum of $25,000 or 25% of the total market value of securities in your brokerage account (which is greater).
Non-Pattern Day Traders have lower requirements. Normally the minimum equity requirement is $2,000. If the account balance falls below this minimum requirement, trading is suspended until the equity threshold is met.
A trader is considered a Pattern Day Trader if he/she makes four or more trades within a period of five business days. One of the following must be fulfilled:
- The number of day trades exceeds 6% of the total trades made on the margin account in the five business day period. If you make four day trades in a period of one week but less than 67 other trades you are considered a pattern day trader.
- The trader has two unmet day trade calls in a period of 90 days
- It is up to the broker to designate you as a pattern day trader if it has reason to believe so.
If you don’t execute any day trades in a period of 60 days, your account will be reverted to a non-pattern day trader. If the above criteria aren’t met, you are considered a non-pattern day trader.
Example:
If an account has a balance of $50,000, the amount of capital for margin is $25,000 ($50,000 – $25,000). The maximum buying power of the account is up to $100,000 (4x $25,000).
Margin Calls
If the maximum amount is exceeded, the broker issues a margin call. It does that by reducing the value of securities owned to a required amount. Traders have five business days to meet the call.
Margin calls can be done automatically, liquidating the positions so the account is back at the required equity. The buying power is reduced between the margin call issuance in that five day period to two times maintenance margin excess.
If traders don’t meet the margin call within that period, trading is allowed only with cash. When the margin calls is covered, restrictions are lifted.
If you have $30,000 above the margin maintenance amount. You buy $140,000 worth of securities (more than 4 times) and sell the position within the same day. You will receive a margin warning either the same day or the next day.
These rules vary from broker to broker and depend on where you reside and your jurisdiction. Brokers can modify these rules to protect their business interests. You should always check the terms & conditions of your broker on what is required and any specific rules they might have.
Know the Risks
Understanding the risks that come with trading on margin is important. Even small price movements can lead to losses when traded with margin. While margin allows you to trade with more than you have, you should always consider the risks. Having a strong trading strategy and risk management in place is a must.
Article Sources:
- SEC. “SEC.gov | Margin: Borrowing Money to Pay for Stocks, https://www.sec.gov/reportspubs/investor-publications/investorpubsmarginhtm.phpl” Accessed April 9, 2021
- Wikipedia. “Margin (finance), https://en.wikipedia.org/wiki/Margin_(finance)” Accessed April 9, 2021
