Margin trading is a great form of leverage when investing in the stock market. Not everyone uses it because not everyone is approved for it, and like every form of loan whether it is a home mortgage or a stock position, tricks of the trade always help.
The following are 9 tips for trading margin with success:
1. Know the interest rate.
Just like every loan, there is an interest rate for what is borrowed. In the case of the stock trading, any online stock broker typically will charge somewhere around 8% a year interest on borrowed funds (rate varies depending on total portfolio value). By understanding the interest rates there is a stronger chance for investment success.
2. Buy over time, not in one shot.
Depending on the portfolio size more often than not investors should buy into a position over time and not with one large order. Try taking half the position at first, find some headway (1 – 3%) to the upside and then add to it from there. This will keep your risk to a minimized level until you have a stronger chance of an overall profitable trade.
3. Understand the rules.
Before trading on margin make sure to understand the rules of the game. A regular trader will be able to attain 100% margin on his or her account, but there are ways to extend this. If declared a pattern day trader by the SEC investors may be able to borrow more than 100% of their account. Always make sure to read the broker guidelines carefully before making the first trade on margin.
4. Margin calls are not good.
Investors never want to have a margin call on their account. A margin call requires the investor to either deposit more funds into their account to offset the losses on margin or sell a position completely. Every position initiated will have a specific price level where if reached a margin call will take place, so be sure to understand this price area before purchasing.
5. Use stop loss orders.
Stop loss orders can help prevent margin calls from occurring and also save an investor from taking bad losses. When trading with full 100% margin there is a realized double exposed to both the upside and the downside. Stop orders can serve as a free insurance policy, so use them.
6. Be extra cautious of any upcoming news.
With any position held on margined funds extra caution should be applied when dealing with upcoming news such as earnings reports. Some investors may be buying extra stock on margin for the very reason that they think positive news is around the corner, but like any investment they should be prepared in case the news does not go their way.
7. Have backup funding in cash.
The worst scenario for any investor is to risk it all, then lose it all, and then proceed to go into heavy debt because of it. By keeping cash on the sidelines to serve as backup funding some of these “worst of” situations can be prevented. Portfolio cash can be used to recover from a margin call or purchase another position to hedge the risk.
8. Stay away from speculating.
Speculating with any money is never a smart thing to do, so don’t do it with a margined position? Utilize margin trading in conjunction with a well defined profit vs loss ratio to stay keep investing disciplined.
9. Stick to your game.
Just like Warren Buffet focuses solely on fundamentals to make sound decisions when investing, every investor should stick to their own set strategy. New investor should read several investment books before pursuing any trading on margin.