Margin trading allows you to borrow money from your broker to buy more securities than you could with just your own cash. While this might sound appealing, margin trading is one of the fastest ways to blow up your trading account. This article explains what margin is and why we strongly recommend avoiding it.
Warning: Margin Trading is Extremely Risky
Margin trading has destroyed countless trading accounts. The leverage that seems attractive can quickly turn against you, leading to losses far greater than your initial investment. We recommend trading only with cash you can afford to lose.
What is Margin Trading?
Margin trading means borrowing money from your broker to purchase securities. Your broker lends you money using your existing securities as collateral. This leverage amplifies both gains and losses.
For example, with 2:1 margin, you could control $20,000 worth of stock with only $10,000 of your own money. But this also means a 10% drop in the stock would result in a 20% loss on your actual investment.
Why Margin Trading is Dangerous
1. Losses Are Amplified
The same leverage that could double your gains will double your losses. A 50% drop in a stock you bought on 2:1 margin would wipe out 100% of your investment. Markets can and do drop significantly, sometimes in a single day.
2. Margin Calls Can Force You to Sell at the Worst Time
When your account value drops below a certain level, your broker issues a margin call. You must either deposit more money immediately or your broker will sell your positions - often at the worst possible prices during a market downturn.
How Margin Calls Destroy Accounts
Starting Point: You have $10,000 and borrow $10,000 on margin to buy $20,000 of stock.
Market Drops 30%: Your stock is now worth $14,000. You still owe $10,000 to your broker, leaving you with only $4,000 in equity.
Margin Call: Your broker requires 25% equity ($3,500). You're close to the limit. Another small drop triggers a forced sale at the bottom.
Result: Instead of a $3,000 loss (30% of $10,000 cash), you lost $6,000 (60% of your cash) because of margin.
3. Interest Costs Eat Into Returns
Borrowing money on margin means paying interest to your broker. These interest charges accumulate daily and reduce your returns even when your trades are profitable. Over time, these costs significantly impact your performance.
4. Psychological Pressure Leads to Poor Decisions
Trading on margin creates enormous psychological pressure. Watching amplified losses can cause panic selling at the worst times. The stress of potential margin calls makes it nearly impossible to think clearly and follow your trading plan.
5. You Can Lose More Than Your Investment
In extreme market conditions, you can end up owing your broker money. If your positions drop faster than they can be liquidated, you may face a negative account balance and owe your broker the difference.
The Better Alternative: Cash Accounts
A cash account only allows you to trade with money you actually have. While this limits your buying power, it also protects you from catastrophic losses.
Benefits of Cash Accounts
- Limited risk: You can never lose more than what you invested
- No margin calls: You will never be forced to sell at the worst time
- No interest charges: No borrowing costs eating into your returns
- Better psychology: Less stress leads to better decision-making
- Sustainable trading: You can survive market downturns and continue trading
The Bottom Line: Avoid Margin
Professional traders and money managers often talk about the importance of survival in trading. The traders who succeed long-term are those who manage risk carefully and avoid situations that could wipe them out.
Margin trading puts you in exactly the kind of situation that can end your trading career. A string of losses, a flash crash, or a gap down can destroy years of gains in days or even hours.
Our Recommendation: Trade only with money you can afford to lose, in a cash account. Build your account slowly through consistent, disciplined trading. The traders who survive the longest are not those who swing for home runs with leverage, but those who protect their capital and compound modest gains over time.
If You Must Trade on Margin
If you choose to use margin despite these warnings, follow these rules to limit damage:
- Never use more than 10-20% of your available margin
- Always have a stop-loss in place before entering any trade
- Keep a cash reserve to meet potential margin calls
- Understand exactly how much you can lose in a worst-case scenario
- Never hold leveraged positions overnight or over weekends
But honestly, if you follow these rules, you might as well trade with cash and avoid the complexity and risk entirely.
Summary
Margin trading allows you to borrow money to trade with leverage, but the risks far outweigh the potential rewards for most traders. Amplified losses, margin calls, interest costs, and psychological pressure make margin trading a recipe for disaster. Stick to cash accounts, protect your capital, and focus on sustainable trading practices that allow you to stay in the game for the long term.
Learn more about protecting your capital: risk management basics and position sizing guide.