As borrowing money to invest is getting popular each day, the term “margin” also become more popular in time. In business, the word “margin” will corresponding to “profit” (as ‘profit margin’ or “our margin has decrease the past 2 years”), but in trading world, “margin” can be equalized with “collateral” or “security deposit” . It relates to some kind of borrowing money for trading.

Margin: a distance from the edge

In printing/word processor, you can see the similar resemblances in understanding “margin”. Margin is a vacant space left as a ‘border’ between the edge of the paper and the content. That is also somehow similar to “margin” in trading, it’s a space between the end of your account and the real profit.

Margin Lending / Margin Loan

Margin Lending or Margin Loan is the most popular form for of borrowing money to invest. It’s one of the easiest loan to be granted by a lender. Hence, it’s also the easiest for trader to get a leverage on his/her account. Usually margin lending / margin loan is only available for stock / share.

The way it works is simple. For every stock, the lender will define a percentage that they want to lend money on. For example: say for BHP stock you can get 75% lending (different percentage for different stock), means if the stock price is $30 and you want to buy 1000 of them (total 1000x$30 = $30k), they will lend you 75% of 30k = $22.5k, and you need to come up with the rest ($7.5k).

Margin Loan Illustration

This 75% is the maximum percentage. So if the day after you buy, the stock go down to $28, then the total value is only $28k. You have borrowed $22.5k, hence your equity is $28k – $22k = $5.5k. Then from the original $30k, your 5.5k is only 18%, means they lend you $81.7% which is bigger than 75% maximum. Unfortunately in this situation you will get “margin call” to ask you to deposit at least another $2k to make the ratio back to 75%.

Furthermore, you need to pay the interest of this loan. If the interest rate is 8% p.a, then the total interest you need to pay is 8% x $22k = 1.76k per year or $147 per month

To illustrate (see picture above), imagine a margin loan is like a bucket. Based on the percentage, the lender put their money into the bucket, and you put your money in the bucket. The rule is that the bucket need to be full all the time. Hence if the price go down (the red tap above opens), your part of the money will be drained to the market and you have to keep the bucket full by deposit more money. If the price go up, the market will pour the money into the bucket and the money will drip into your ‘profit’ bucket.

Margin Trading

The other form of lending for trading is what we call “margin trading”. This is the lending where the lender will lend you 100% of the amount. But they will ask some percentage as collateral or security deposit or “margin”. This kind of trading usually available on high leverage trading such index trading / e-minis or forex trading or commodity trading.

Let’s use the same example above. You want to buy 100 share of BHP with $30 each. And say, the lender ask you to provide 25% margin. Then the lender come up with full $30k, and you put 7.5k in the account as collateral.

Margin Trading Illustration

So if the price again goes down $2 the next day, you need to top up your account by $2k just exactly like the margin lending.

The difference is on the interest. Since you borrow the whole amount, then you will pay 8% x $30k = $2.4k per year or $200 per month

To illustrate (see picture on the right), also imagine a margin trading is like a bucket. Based on the percentage, you will be asked to provide your money as collateral and the lender just sit on it. Then the lender put their money to fill the whole bucket. Again, the rule is that the bucket need to be full all the time. Hence if the price go down (the red tap opens), you need to replace the lender money straight away and maintain the bucket full. If the price go up, the market will pour the money into the bucket and the money will also drip into your ‘profit’ bucket.

Usually if the account is used for day trading (buy and sell within the same day – no overnight position), the trader does not need to pay interest, just the collateral. This is one of the factor why this kind of trading such as e-minis trading become very popular (Got high leverage without have to pay the interest).

Conclusion

On both margin loan and margin trading, the borrower (you) have to come up with additional money if the price go down to maintain the ratio. If the price go up, the excess money become the profit.

The only difference between margin lending and margin trading is that the borrower (you) will have to pay more interest on margin trading since the lender lent the whole amount (100%)

Denis Kristanda