Margin Trading: Avoiding the Traps

Margin trading is one of the easiest ways to obtain greater profits.  Of course, with more margin comes more risk, but a few steps can be made to mitigate the chance of loss.

Day Trading Margin Rules

Speculative investment and margin trading have for a long time been a top concern among regulators.  As a result, day trading margin rules and requirements are always changing and routinely inspected to protect uninformed investors from losing it all with high-powered margin trading.

The most important of the day trading margin rules is the balance requirement.  Today's day trading requires a minimum of $25,000 in cash or combined securities, and should balances fall below the $25,000 requirement, day traders will have to deposit more cash before future day trading activity can take place.

Margin trading is also typically restricted to 2:1 on retail brokers.  Unlike other day trading margin rules, the margin allowed is unlikely to go beyond 2:1, since it was margin trading that is most suspected for some of the largest drops in stock market history.  Some institutions offer margin trading of 10:1 or greater for their own internal traders, but total margin companywide is usually restricted to 2:1 by their own risk management rules.

Mitigating Risk

Margin trading requires that investors enter positions that are highly liquid and can be sold at any time.  Since margin trading is essentially trading with borrowed money, there is a substantial risk of loss.  Trading illiquid securities leaves you open to the possibility of a negative account balance should a stock fall quickly without the availability to make a trade in or out of a position.

Day trading margin rules do, however, require brokers to exit a position when your account balance nears zero.  This process is known as a margin call, where all the positions in your account are liquidated before your account can fall in value below zero.  At the time of a margin call, you will be required to deposit more cash, or all your positions will be closed.  This process usually happens in a matter of minutes for highly-levered traders.

Of course, one of the best ways to stay safe when margin trading is to use very little margin.  While brokers offer up to 2:1 leverage, most traders would be best to use only a fraction of that leverage, or use leverage on only a fraction of their account.  A $5500 position on a $5000 account (1.1:1 leverage) is far safer than a $10,000 position on a $5,000 account.  Besides, additional margin use generates higher interest payments and costs.

Stepping Up to Margin Trading

Margin trading and acquiring an account with day trading margins is a process that is best done after you have amassed at least some experience and profitability in the financial markets.  While day trading margin is perhaps safer than long term margined positions, there is more risk associated with leveraged trading.  Do not – absolutely do not – rely on day trading margin rules to protect you against loss.  These rules are guidelines.  They are not absolute, and they should be treated as the minimum requirements for safe trading.
Tim Ord
Ord Oracle

Tim Ord is a technical analyst and expert in the theories of chart analysis using price, volume, and a host of proprietary indicators as a guide...
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