Margin trading: An investment facility
While both investment and margin trading are tools to trade in stocks and other securities, investment is the actual process while margin trading is one of the facilities to invest. Both ultimately are geared towards providing you profitable returns, given how you work out your strategies. Now, in order to address the ambiguities surrounding these two subjects, let us first look into them individually.
What is an investment?
An investment is essentially an asset because its objective is to produce value. You buy and hold the investment for a period that gives you the maximum returns. There are a plethora of investments in the market viz. stocks and bonds, bank deposits, gold, real estate ETFs, and mutual funds, and each one of them are to be traded differently. You may invest in many of them together to make a diversified investment portfolio, which is considered to be healthy as it balances out the risk. Hence, the bottom line is that investment is an item held by you, not with the aim of consuming it, but with the aim of generating income.
What is margin trading?
Margin trading is trading with borrowed funds. When it is not feasible for you to buy more securities, you can borrow funds from your broker and fulfill the transaction. For this, you need to have a margin account and have a certain corpus in it, which fundamentally is the margin and which also acts as a collateral of the loan. You get to trade with more funds, therefore, the prospect of higher returns increases. However, likewise, the probability of incurring more losses also increases. Therefore, you need to exercise caution and prudence while venturing into margin trading.
What makes them distinct?
Although margin trading comes under the ambit of investments itself, it is not a type of investment but rather is a facility provided to invest. These are two different concepts altogether. The following points of differences better elucidate the same:
- There is no fixed holding time period for investments in general. It depends on what kind of investment you own or finance. For instance, mutual funds can be actively traded and exchange traded funds need to be held for a longer time period. Therefore, depending on your convenience, you can choose what best suits your interests. Margin trading, on the other hand, is mostly intra-day trading. You trade within the confines of a day on borrowed funds. So, there is a time stipulation for it.
- You may or may not choose to receive the assistance of a broker while investing in securities that do not require a great deal of market research and analysis. However, margin trading is trading on the funds of the broker itself, therefore, the intervention is absolutely called for.
Risk and returns
- You have options to either invest in securities that give a gradual and stable return over a period or invest in one which can bestow short-term benefits on you. Again, it depends on your priority and your financial goals. Margin trading is known for being comparatively riskier. They can either double your gains or even double your losses. So, precision and prudence have to be exercised to get profitable returns.
Should you venture into margin trading?
Margin trading can be a suitable option for you if you have prior experience in trading in the market. For an absolute newcomer, it can be intimidating as well as confusing. Moreover, if you do have a risk-absorbing capacity and are looking for higher returns in the short term, this can serve your purpose. Moreover, since margin trading is practiced on borrowed funds, it entails payment of interest too, like any other loan. So, regardless of whether you earn profits or incur losses, you have to pay interest on the amount borrowed. Therefore, already having a stable corpus set aside in case of exigencies becomes indispensable.
Margin trading can give you great returns, but with great returns come great risks too. And if you think your portfolio or financial well-being would not be drastically disturbed in case things go the other way, you might as well try your hands on margin trading.
Frequently asked questions
1. Is it worth trading on margin?
- Margin trading increases the purchasing power of the investor and hence provides more scope by using borrowed funds. However, with greater amounts comes greater risk as well, and hence, it should be done prudently.
2. Is margin trading good for beginners?
- Considering the risk involved in margin trading, if a beginner trader intends to venture into it, they should ideally go for big companies with relatively more stable prices which pay a good dividend.
3. What are the disadvantages of margin trading?
- Although margin trading is fairly popular, there are certain risks involved in the activity, which should be weighed against the pros. It involves maintenance costs, payment of interests, and greater risks.
4. Is margin trading a good idea?
- Margin trading can prove to be profitable for those who are experienced. It essentially is trading on borrowed funds and entails higher risk. Therefore, the person venturing into it should know what they are getting into.
5. What happens if you lose money on margin?
- If you end up losing money on margin, then you may be called to pay more funds in order to compensate or to sell off some of the securities in order to be able to pay off the amount lost.