Message from TraderJanie
If you want to trade, “on Margin” you should understand what it entails. I’ve traded on margin before and didn’t quite understand what I was getting into until I got the dreaded Margin Call. Fortunately, I was able to recover from it quickly but it was what I call an SEE (Significant Emotional Event) and one I will never forget.
Explaining Leverage with Mortgages
Most people are familiar with leverage in the form of mortgages. You take out a home loan with 20% down, you are leveraged at 5x. In other words, you are buying and controlling 5x the value of your funds by borrowing “other people’s money.”
Traditionally, since home prices have generally appreciated except for certain times in the past, and in certain cities, this has proven to be a wise use of borrowed funds, particularly when mortgage rates are low.
Under current conditions, the cost of borrowing against securities, known as the margin interest rate, is low at many brokerages, especially at Interactive Brokers (IB) where the current maximum rate is 1.91%. If you have a stellar trading system in which you trust AND less than full leverage is being utilized, the use of margin can be a practical way of increasing returns.
But beware, trading on margin can entangle you in certain risks, most of which are exacerbated by full leverage, which is 2x for retail traders who hold positions overnight. In fact, many of the horror stories about margin trading arise from trading volatile, small-cap stocks that are fully margined. In the next part of our discussion, we will detail some of those risks and demonstrate how they can be controlled by trading larger-cap stocks at 1.5x leverage, which involves borrowing 50 cents for every 1 dollar that we put up.
So, here at Quantitrader, we will be introducing a portfolio that makes use of borrowed funds with controlled risk to increase returns. It will be called SP500 Leveraged, sort of like the SP500 Margin on steroids.
I think that you will find it very interesting, and potentially very attractive for traders who have a margin account.