Margin Trading basics
About this lesson
In this video, I will explain what margin trading is. Using a numeric example, I will also show how return on investment in margin trading is calculated.
Buying on margin
Buying on margin means borrowing part of the purchase price from your broker. The stock you buy is the collateral for the loan, and you pay interest on the amount borrowed.
- The initial margin is the share you must pay yourself. In the US, the Federal Reserve sets the minimum at 50%.
- The maintenance margin is the minimum equity you must keep in the account afterward, often 25–30%.
The margin percentage
Margin = Equity ÷ Value of the stock = (Value of stock − Loan) ÷ Value of stock
Example
You buy 200 shares at $100 ($20,000). You pay $12,000 yourself and borrow $8,000.
Initial margin = 12,000 ÷ 20,000 = 60%
How margin magnifies returns
One year later, ignoring interest for now:
| Price change | New value | Equity (value − $8,000 loan) | Return on your $12,000 |
|---|---|---|---|
| +20% ($120) | $24,000 | $16,000 | +33.3% |
| 0% ($100) | $20,000 | $12,000 | 0% |
| −20% ($80) | $16,000 | $8,000 | −33.3% |
A 20% move in the stock becomes a 33% move in your money. Borrowing magnifies both gains and losses.
With interest of, say, 9% on the $8,000 loan ($720), the returns drop to +27.3% and −39.3%.
Formula
Return = (Ending equity − Initial equity − Interest) ÷ Initial equity
This lesson is for education only and isn’t investment advice.