Advantages & Disadvantages of Margin Trading

When used responsibly, an investor who is making smart investment decisions can receive significant benefits from trading on a margin. The main advantage is that the use of leverage provides an opportunity for earning a large profit on an investment that you never fully pay for.

However, you must have a very clear understanding of what you risk losing if the investment doesn’t fare as well as you had planned.

Some disadvantages to trading on margin include magnified losses, contractual obligations required by your broker, and less control of your investment portfolio. If you are thinking about opening a margin account, it is very important to remember that you can lose more money than your original investment. In the event of a margin call, you may be required to deposit additional funds into your account or sell your securities in order to meet the maintenance requirements. Also, be aware that if your margin call is not filled, then your broker has the right to sell some or all of your securities without your permission.

Bottom Line

After reading through this chapter, you should have a better understanding of what margin is, how to trade on a margin, the requirements and responsibilities associated with a margin account, and the advantages and disadvantages associated with trading on a margin. Margin trading can prove to be very beneficial in an ideal situation, but it is important to realize that not everything goes as planned. If you are considering the possibility of opening a margin account, understand the potential losses that can be associated with a bad investment decision, and be sure that you have the financial security to be able to cover your losses in a worst-case scenario.