Definition of Margin Trading
Margin trading is when you borrow additional funds from your broker for trading. Each broker has their own margin trading requirements which is dependent upon a number of factors, such as the volatility of the stock, account size, etc. In order to trade on margin, you will need an approved margin account.
Requirements for a Margin Account
In order to create a margin account, you will need a minimum deposit between $2,000 and $5,000. This deposit is used as collateral against your trading activities. There will also be some sort of application you will have to complete, in order to have your account elevated from a cash account to a margin enabled account. Once an account has been approved, you will only need 50% of the cash on hand to purchase or sell short a stock. For example, if you wanted to purchase $10,000 worth of stock, you will only need $5,000. The one caveat to this, is that for some volatile stocks, there are strict margin requirements. There are some stocks that will require you have up to 80% of cash required to hold the position.
Maintenance Margin
For each stock you trade, there will be a minimum cash balance required to hold the position. This maintenance margin is calculated real-time and brokers will require that you keep the minimum cash on hand to maintain the positions, or (1) you will have to liquidate all or part of your position, or (2) deposit more cash. If you are on the wrong side of the trade, this can become a slippery slope as you will quickly find yourself depositing funds quite frequently.
Margin Calls
My rule regarding margin calls is not to answer them, meaning, do not fund the account to get it above the maintenance margin requirement. If you get a margin call, it is because the market is signaling that you are incorrect regarding your trade. You do not want to throw more money into a bad situation. More times than not, you will be happy you cut your losses short and sold the stock (or covered it if you were short).
Interest
Brokers do not provide margin for free, this is capitalism. Brokers will charge you interest daily for your positions. This interest rate is much lower than a standard loan, but nonetheless it is money out of your pocket. So, it is in your best interest to use margin for short-term trading activities to avoid the fees.
See You At the Top,
mysmp.com