If you utilize margin in your trading, you need to understand how margin works, how much it works, and how it can work against you. In this article we’ll talk about how margin rates affect buying power.
What is Margin?
Margin is credit that your broker extends to you to trade.
For example, in a $10,000 trading account, you might be able to utilize up to $20,000 in buying power for overnight trades and $40,000 for intraday trades.
In the United States, there are regulations on how much margin you can utilize within a standard brokerage account.
These are typically double your account equity for overnight trades and quadruple your account equity for intraday trades.
However, most brokers offer clients with more than $125,000 in account equity a more fine-tuned margin structure, called portfolio margin, enabling clients to use much more margin than would be allowed in a standard brokerage account.
When you trade on margin, you’re not trading with your own money, which makes it inherently riskier.
Beyond the fact that margin multiplies both the size of your losing and winning trades, it also reduces your trades’ expected value because you’re paying interest on your margin.
In order to trade with margin, you need to open a margin account with your broker. This typically involves answering some suitability questions and signing risk disclosures.
Brokerage Margin Rates Updated for 2021
Most retail brokerages charge very high margin rates.
At the time of writing, most charge around 7%, meaning that if you held the position for a year, it would cost you 7%. That’s pretty steep, considering that’s close to the historical annual return of the S&P 500.
Here’s a table of margin rates for some of the top discount brokerages.
We’ll use each firm’s highest posted margin rate. Note that these are all subject to change at any given time, so keep updated with each respective broker’s website.
Note that low margin rates are one of Interactive Brokers‘ key offerings. Their margin costs just a fraction of the rest of the industry. Traders utilizing a high margin level are probably best suited to an IBKR Pro account.
The saved costs in margin would far outweigh the commission costs that IB charges, especially since you’ll probably realize better execution due to IB’s direct market access.
But cheap margin loans aren’t the sole reason to use a broker. This is what makes the discount brokerage industry so interesting right now. The competition is fierce as brokers race to differentiate themselves among an industry-wide consolidation into the larger players.
While some of the brokers on the higher end of the above table have very expensive margin, they also have terrific offerings besides that.
TradeStation, for example, has probably the strongest free active trading platform, while TastyWorks has an extremely intuitive options trading platform.
The Risks of Using Margin
Of course, all margin trading heightens risk because you’re increasing exposure and using someone else’s money to do it. However, most people know that. We’re going to highlight a risk of trading on margin that most traders don’t fully appreciate.
We’ll say it for the third time: when you’re trading on margin, you’re partly trading with someone else’s money–specifically, your broker’s money. And they dictate the terms. This means that if they feel like the securities you’re trading are too risky.
They can alter the margin requirements of securities at any given time and issue you a margin call, forcing you to either liquidate your position or give your broker more collateral.
You’re basically “signing your life away” with most margin account contracts, giving your broker massive leeway over how they treat your margin.
Many traders learned this for the first time throughout last week’s short squeeze mania. There were reports that brokers began liquidating positions in stocks like GameStop (GME) and Koss Audio (KOSS) without their clients’ permission. In the majority of these cases, the traders were likely utilizing margin.
The drawbacks of utilizing margin, magnified losses, potential margin calls, and paying interest are stark reminders that there’s no free lunch in the financial markets.