What can you do when you’re margin trading?
1. Leverage your assets for a bigger return
If you buy shares on a margin, you’ll be able to leverage what you gained. Then you’ll be able to buy even more shares than you ever could if you went only with cash. We’ll explain it all on several examples that will paint a rather interesting picture. You will see that share buying on a margin can allow for almost a double investment return when compared to a return that was obtained without margin.
For example, you have $10,000. A margin loan is 50%. If the stock price is $100, without a margin, you can buy 100 shares, for a total of $10,000. On the other hand, if you are using margin, and the stock price is the same, $100, you will purchase 200 shares, for a total of $20,000
Let’s say that those shares rise from $100 to $150 after 6 months.
If you bought them without margin, your share sale proceeds will be $15,000. Your gross gain will be $5,000 without commissions. Meaning that you will have a 50% investment return.
On the other hand, if you bought those same shares with margin, your share sale proceeds will be $30,000. Your gross gain without commissions will be $10,000. There will be margin loan interest, that is 8.5% or $425 in this case. In the end, you will have a net gain of $9.575 and a 95.75% return on your investment.
2. Portfolio diversifying
If you use it sensibly, a margin account can be a great asset that will hedge or diversify your portfolio. For instance, if you are focused on a few sectors, you can use your margin account to add positions in other sectors. This will improve the diversification of your portfolio.
On the other hand, if your portfolio is already diversified, and you want to hedge downside risk, you can use options for hedging, or to short sell a specific sector or the broad market. When you have in mind that short selling and certain options trades can only be done in a margin account, it sounds like this option is definitely worth trying. Sure, short selling has its own risks. But, there’s no stock market that’s completely risk-free, that’s why the potential gains are so high as well.
3. Carry trade
This term means that you borrow at a lower interest rate, and then invest in something that can give you a higher return. While carry trades of currency are most used in the currency market, a savvy investor can use it in the stock market with quite an effect as well.
For instance, there’s an investor who has $50,000 and he takes on margin debt for the same amount and invests the entire amount in a diversified portfolio. Let’s say that that portfolio yields 12%. If the margin loan interest rate is 8.5%, that investor will generate 3.5% more on the entire portfolio than he would have if he had a cash-only portfolio with no leverage. That means $1,750 more earned on that investment.
4. Take advantage of opportunities as they arise
When you trade shares on a margin, you’re able to take good opportunities as they appear. Just imagine the perfect stock showing up, and all your assets are trapped in investments? You would have to either pass on the opportunity, sell your investments, or find a third way to get cash. This way you won’t have to get rid of your existing investments to raise cash, and you won’t have to try and get it from other sources.