Margin trading is a form of investing where you purchase stocks by borrowing funds over a short term loan from your brokerage. Investors use margin accounts to purchase a big lot of shares for a comparatively small investment. To do this, investors must open a margin account where an initial sum is invested either in cash or through marginable stocks as collateral holdings.
Brokerages charge interest over these trades, and the investor must maintain a minimum margin amount in their margin accounts, in order to avail this facility called as a maintenance margin. In case the investor suffers a loss where their account balance drops below the maintenance margin, a margin call is initiated by the brokerage intimating the investor to cover the loss incurred on the maintenance margin, by adding cash or liquidating marginable holdings. The holdings in your account may also be referred to as securities. The following can be considered as marginable securities in general, although it is recommended that you confirm the same with your broker.
The term Commodity Futures refers to a proposed agreement between buyers and sellers of raw material to trade at a specific date in the future at a pre-determined price. The contract is for a previously set amount that is either higher or lower than the commodity’s current market value. Purchasing a commodity allows you to fix its price in the future, irrespective of its future market value. That way, you reduce the risk of paying more for the commodity in case its cost rises. On the seller’s part, a futures contract assures that the price determined at the time of sale, is payable by the buyer upon delivery, thereby reducing the risk involved during a fall in the market value of the commodities in question.
Company Stocks and ETFs
A company’s stocks are shares that can be bought and traded on the stock market. You can purchase them from your brokerage firm through a trading account. The values of stocks rise and fall on the market due to various factors that affect it. In a nutshell, investors purchase stocks at their current value on the stock market and then sell it for a profit. ETFs, or exchange-traded funds are a type of security that are marketable on the stock market. They track an index, a commodity, bonds, or a combined collection of assets, similar to a Mutual Fund. The difference between a Mutual Fund and an ETF is that it can be traded like any common stock on the stock market and like stocks; they experience price variations all throughout a business day from being traded.
Not all securities are marginable, however, brokerages usually restrict margin trading into Penny Stocks, Mutual Funds securities or Initial Public Offerings (IPOs) to their customers keeping their daily risk aspect in mind. In fact, some brokerages have added restrictions against margin trading into specific stocks, an aspect that you must clarify from your broker.