Margin Trading
Trading on margin means borrowing funds from a broker to purchase securities. You only pay a certain percentage (or margin) of the value. This allows you to trade beyond your own available funds. The leverage is provided by the broker, who extends you a loan to open the position(s). In this way, leverage is created, which can be used to increase profits. Thus, the advantage of trading on margin is that it can increase potential profits by taking larger positions. This also means that your potential losses can be substantially higher if the positions do not have the desired results, and you may lose more than your initial investment. Moreover, because you borrow funds, you are responsible for repaying the loan plus interest to the broker.
Trading on margin is only for experienced investors with a high risk tolerance. You may lose more than your initial investment.
A simple example
You currently possess €3,000 in cash and intend to acquire €10,000 worth of stocks. To achieve this, you have two options:
- Option one involves transferring additional funds to your account, waiting for their processing, and then proceeding with the stock purchase.
- Alternatively, you can choose to allow your broker to use your existing cash as collateral, thus granting you access to the necessary additional funds for the €10,000 purchase. In this case, the broker will request a collateral, also known as an initial margin, of €3,000. The remaining amount of €7,000 is lent to you by the broker. On the € 7,000 you borrowed you pay debit interest, calculated on the same day.
Margin trading allows you to take on greater obligations without having the corresponding cash on hand.
Now let’s assume the stock you bought worth €10,000 goes up by 1% and is now worth €10,100. The gain of €100 is all yours. What does this mean for your equity? It rises from €3,000 to €3,100. This is an increase of (€100/€3000) = 3,33% although the stock price only increased by 1%.
Now, consider a scenario where the stock you purchased for €10,000 decreases by 1% and is now worth €9,900. The loss of €100 is entirely on you. What does this mean for your equity? It drops from €3,000 to €2,900. This is a decrease of (€100/€3,000) = 3.33%, even though the stock price only decreased by 1%.
| Trading with only your own funds | Trading on Margin | |
|---|---|---|
| Initial Deposit | €3,000 | €3,000 |
| Available to invest | €3,000 | € 10,000 |
| Purchase | €3,000 | € 10,000 |
| Remaining available funds | € 0 | € 7,000 |
| Profit/Loss from Investment (1% increase/decrease) | (-) € 30 | (-) € 100 |
| Return on your capital | (-) 1,00% | (-) 3,00% |
Note: This example does not take transactional costs or financing costs (debit interest) into account.
How does trading on margin work?
A margin account empowers you to engage in trading with additional funds, allowing you to take larger positions, thus increasing your available capital beyond your initial cash amount. Trading platforms provide clear insights into the advantages of using this approach.
- A negative cash balance indicates that you are borrowing funds to facilitate your trades. In that case, you will pay debit interest on your negative cash balance.
- You can leverage your available funds by using your securities as collateral, enabling you to access additional cash for your trading activities.
When making a purchase, such as €10,000, you’ll only need to provide a fraction of that value as collateral, commonly referred to as the Initial Margin.
Any margin account whose value decreases below € 2.000 (or equivalent) will automatically be considered a cash account. Thus, if you have a margin account, but the value falls below € 2.000, you will no longer be able to trade on margin, for example, when writing options.
Pros and cons of a margin account
- A margin account provides the ability to invest in leveraged products such as turbos, sprinters and speeders.*
- The use of margin allows investors to achieve meaningful results even with less volatile products.*
- A margin account allows investors to sell (write) options.*
- A margin account allows investors to go short on stocks.*
- Investors can trade futures with a margin account.*
- In margin trading, both profits and losses are magnified, meaning you can lose more than your personal investment.
- Failure to meet maintenance margin can result in forced liquidations of positions in your investment portfolio.
- Like borrowing money, trading on margin is not without cost. You pay debit interest on the borrowed amount.
- Using leverage can increase the complexity of managing your investment portfolio.
- Your loss may be greater than your deposit.
* Provided that your account balance and trading experience permits this.
See your margin impact
The initial margin changes only by a fraction of the purchase amount as indicated by the Change in the section about Initial Margin.
Right-click a pending order and select Check Margin Impact from the menu.
The order preview window shows the impact of the order on your account. The column Change in the Balances section indicates how margin requirements will change post-trade.
To view the impact on the margin, click on Preview in the bottom right corner. After this, the margin display for the current position opens up.
Overview about margin requirements
The calculation of margin in theory
Interactive Brokers uses a risk-based model called Portfolio Margin to determine margin requirements based on historical volatility. There are different calculation methods depending on the product, two of which we explain here:
Both are mathematical methods to simulate various scenarios for your portfolio and calculate the risks of options and futures:
- TIMS scans your entire portfolio to analyze risks and simulates the two largest positions at ± 30% and all others at ±5% to examine the risk of low diversification. The calculation also considers the impact of extreme price fluctuations and high concentration of risk. Therefore, changes in implied volatility of options, large positions, and remaining days until expiry have an impact, too. Please be aware that the initial margin requirement is usually higher than the minimum maintenance margin requirement.
- In contrast, the Singleton Margin Method calculates the margin requirements for small-cap stocks with market capitalization of less than $500 million. It enables the simulation of price fluctuations, with an increase of 30% and a decrease of 25%. The system selects the scenario with the highest possible loss and applies it as a requirement for your portfolio. Margin requirements for stocks typically range from 15-30% of the market value depending on the calculation.
The Chicago Mercantile Exchange (CME) developed SPAN as a risk-based method for calculating margin requirements for futures and futures options. Then, test your portfolio under hypothetical scenarios to examine price changes and the implied volatility of options. We use “in-house scenarios” to examine extreme price fluctuations and their impact on out-of-the-money options. We choose the scenario with the greatest possible loss as the margin requirement.
FAQ
If you want to trade on margin, you can upgrade your cash account to a margin account at no extra cost. However, borrowing funds accrue interest which you need to pay.
You should go to the Client Portal and select Settings. Then, navigate to the Account Configuration section and click on Account Type. Now, you can continue by providing your current experience with margin trading and then sign the margin risk disclosure.
Interactive Brokers does not issue margin calls, so liquidates assets when the margin threshold is reached. Accounts receive real-time Margin Warning information.
Generally, it is not necessary to trade on margin. Albeit, some products require you to upgrade to that account type:
- Futures
- CFDs
- Short options and certain option strategies
You must be at least 21 years old to trade on margin. The deposit value (net liquidation value) must be at least 2,000 EUR. If the deposit value is lower, you will automatically trade as with a cash account. You can read more about our minimum requirements on the page of your local branch.
You cannot buy all financial instruments on margin. Risk assets like Penny Stocks, Warrants, and issuer products often demand payment with 100% of your own funds.
The exchanges and the broker itself define the requirements for initial margin and maintenance margin. Generally, the margin requirements change once per day, but this can change. Additionally, some future contracts have particularly low intraday margin requirements.
Disclaimer:
The author’s remuneration is not directly or indirectly related to his/her viewpoints or ideas.
Neither do any other conflicts of interest apply in accordance with the policy around the conflicts of interests of LYNX.
The information on this webpage is neither considered as investment advice nor an investment recommendation. The page shows data that has been prepared by LYNX as general information / marketing information for private use by investors but is not intended as a personal recommendation of particular financial instruments or strategies and does not take into account the individual investor’s particular financial situation, investment knowledge and experience, investment objectives and horizon, or risk profile and preference.
Show full disclaimer
