Introduction

A margin account is generally used by investors to leverage their investments and scale up their purchasing power. At the meantime, trading with a margin account can magnify losses which create higher risk than conventional trading accounts do.  In this topic, we will be explaining on what potential; risk that can arise from trading with a margin account.

To have a better understanding on a margin account, please proceed to MQ Trader – Benefits of Margin Account.

Risks of Margin Account

The double-edged sword of leverage

Margin trading can magnify your losses as dramatically as it can boost the profits earned.

Here is the example if the share price of a purchased stock drops:

When the share price falls by RM5 after 6 months, the losses which are incurred on both accounts are as shown below:

Margin Call

Margin call is a dreadful risk that can be contributed by the decrement of stock value leading to drastic fall of equity to the level below the marginal ratio required by the broker. Therefore, investors will be notified to pump in sufficient amount of cash or paid securities to maintain the minimum marginal ratio. This is the time when the risk comes in if traders are unable to fulfill the minimum marginal ratio requirement.

Forced Liquidation

Margined securities will be sold immediately without further notice if investors are unable to meet a margin call. Forced liquidation can create a substantial amount of losses especially in a bearish market when the securities are disposed at an undesirable price.

Interest Charged

Despite of lower interest rate of a margin account as compared to other collateral accounts, the interest charged can be added up to create huge losses like a snowball effect over the time. Besides, the effect can be even serious if the interest rate rises, as interest rate can fluctuate when the investor has margin debt. Hence, it can increase the interest burden of the investors in a rising interest rate condition.

Close Portfolio Monitoring

The possible risks as mentioned above force investors to have much closer portfolio monitoring from time to time. This can lead to higher stress to investors which may affect their performance in their daily routine. Thus, risk management for trading with a margin account is very important to be practiced, so as to avoid big losses in investment.

In the next blog post, we will be discussing on the methods that can be taken to minimize the risks of a margin account. Please stay tuned for MQ Trader – Risk Management of Margin Account.

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Disclaimer

This article does not represent a BUY or SELL recommendation on the stock covered. Traders and Investors are encouraged to do their own analysis on stocks instead of blindly following any Trading calls raised by various parties in the Internet. We may or may not hold position in the stock covered, or initiate new position in the stock within the next 7 days.

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