David Waring

In our last lesson we continued our course on the logistics of stock trading, with an introduction to trading on margin. In today's lesson we will continue our discussion of margin, with a look at some of the rules surrounding trading on margin.

Because the stock market is an exchange traded market, many of the rules and regulations surrounding trading on margin are standardized. This is in contrast to the spot forex market, which we learned about in our last course, where it is generally the broker that sets margin requirements. A second difference that it is important to understand is that unlike in the forex market where you do not pay anything extra when trading on margin, in the stock market you pay interest on the money loaned to you by your broker, so there is an extra cost to trading on margin in the stock market.

Now that we have that out of the way, the two most important terms to make sure you understand before trading stocks on margin, are what are referred to as initial margin and maintenance margin.

Initial margin is very simply the percentage of a stocks price that you are required to have in your account, when purchasing that stock on margin. Regulations stipulate that the minimum margin that an individual can trade on under normal conditions is 50% (although some brokers require more). So, for example, if you were buying $10,000 worth of a particular stock, the you would be required to have at least $5000 in your account in order to do so. If you had more than this then this would be no problem, but if you had less than this you could not purchase the stock.

Maintence margin on the other hand, is the amount of money you are required to have in your account once the position is opened. Basically there are two different margin requirements for opening and then holding a position, to give the trader room for a position to move against him or her once it is opened, without having to put up additional margin funds. The minimum maintenance margin that a trader is required to have in order to hold an open position, is 25% (although some brokers require more). So, using our same example where a trader purchased $10,000 worth of stock, once the position is open, the trader will be required to have 25% of the current market value of the position in his or her account in order to continue holding the position. If the price did not move, then the trader would need at least $2500 in his or her account in order to continue holding the position. If the position moved against the trader however and fell to a market value of $9000, then the trader would need (.25*9000) or $2250. Similarly, if the position moved in the traders favor and moved up to a market value of $11,000, then the trader would need $2750 in order to continue holding the position.

If the trader falls below the minimum maintenance margin requirement, then the traders broker will issue what is known as a margin call. A margin call requires the trader to either deposit additional funds in their account or sell some of the securities that they hold in order to bring the cash in their account up to the minimum maintenance requirement. Depending on the market situation and the rules in a specific brokers margin agreement, the broker may also sell off a traders positions at their discretion once a margin call is issued. As you can see here it is important that traders who use margin adhere to proper money management techniques, so they can avoid a situation where they are issued a margin call and their broker sells off some or all of their positions at the brokers discretion.

One last note on margin, is that regulations require that a trader have at least $2000 in their account in order to trade on margin, however some brokers may require a higher level.

Thats our lesson for today. In our next lesson we will look at how to monitor your margin levels on the ThinkorSwim platform so I hope to see you in that lesson. As always if there are any questions or comments please leave them in the comments section below, and good luck with your trading!

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Disclaimer: Trading is risky and can result in substantial financial loss. As always my posts are simply one traders opinion and should not be taken as trading advice. I am not a financial adviser so everyone please do their own analysis and take responsibility for their own trades.

Unregistered

hello dave,

i find your courses great , keep up the good work. I have one question on margins. if the stock i purchase on margin goes up, which creates instant equity or value, then why does my margin maintenance requirement go up also ???? it doesn't make sense that because I have a profit, more money is required to hold the position. kindly explain.

thanks ben