If you want to trade, “on Margin” you should understand what it entails.
Once you get a dreaded Margin Call, you learn about Margin very quickly.
I’ve traded on margin but didn’t understand what I was getting into. That was 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 you trust AND use less than full leverage, the using 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.
I think that you will find it very interesting, and potentially very attractive for traders who have a margin account.
Part 2 can be found here
“We don’t have to be smarter than the rest. We just have to be more disciplined than the rest.” Warren Buffet
ALWAYS FOLLOW THE RULES
Check our out the Performance Matrix for our algorithms and sign up today.