Two ideas that are very important to the world of day trading are margin and leverage. Taking the time to understand these concepts will make it easier to understand the options at your disposal as a day trader. Margin is a loan given by a broker which allows the trader to leverage the assets in his account so that he can enter larger trades.
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Leverage is the increased buying power that you get with a margin account. Basically, leverage allows a trader to enter a trade for less than full price, giving him access to larger positions than he would normally have access to. Day trading leverage strategy can be very profitable, but it can have its pitfalls, as well.
Is trading on margin a good ideaprofits
Although trading on margin can increase your potential day trading by leveraging your buying power, they can also amplify your losses if your trades do not work out. That is, it is possible to lose more than 100% of your initial investment. In order to use day trading leverage strategy to its full potential, it is essential to understand all of the risks and contributing factors that can define if trading on margin is a good idea.
Some of the more important things to understand are margin call, forced liquidation, and other risks such as high interest rates on margin accounts. Although these pitfalls can create serious setbacks for an inexperienced day trader, the advantages for a clever day trader can be very rewarding.
Examples of Leverage Trading Scenarios
One of the most important things to keep in mind when thinking of leverage trading is the difference between pattern and non-pattern day traders. When day traders meet a certain amount of criteria, they are considered “pattern” day traders, and the requirements for them to qualify for margin accounts change.
Pattern day traders must keep a minimum of $25,000, but they can purchase up to 4x the excess in their account.
For example, an account with $40,000 is $15,000 in excess of the minimum, meaning the trader can trade with up to $60,000 ($15,000 x 4). This obviously gives the day trader more buying power, allowing him to potentially maximize profits from his trades. However, as we mentioned before, trading on margin can also amplify your losses.
Imagine a stock trading at $100 per share, and you are confident that it will rise. You purchase the stock with 2:1 leverage, using $10,000 of your own money to purchase $20,000 worth of stock. Without leverage trading, you would not have been able to purchase as many shares, meaning your potential profits and losses would be lower.
However, imagine the price of the stock falls by 25%. With the shares now only worth $75, your investment is now only worth $15,000. After paying back $10,000 to the broker, you are left with $5,000, which is a 50% loss. The loss would only have been 25% if you had not been trading on margin.
This represents an example of how leverage can go both ways when it comes to day trading leverage strategy. Although shouldering the extra risk of a margin trade can be risky, the increase in profits for a confident trade can be quite substantial. Learning how to calculate the risk of margin trades, and carefully decide on how to leverage your buying power is an essential step to becoming an expert day trader.
Learn margin trading
Like any other aspect of day trading, the desire to learn margin trading as good as possible is essential to using it properly. It can be tempting for inexperienced traders who think they know what they are doing to trade on margin with stocks that they don’t understand as well as they think they do. Although increasing your buying power can give you a lot of advantages and opportunities, it can also do a very good job of maximizing your losses.