Margin trading occurs when an investor in the stock exchange market buys more shares than they can afford. The stock exchange broker lends out the funds to an investor to purchase the shares in such cases. However, the broker restricts the said collateral as security for repayment in return. More investors are embracing margin trading. Investors who feel like their shares will rise in value have an incentive to purchase more shares to earn larger profits later. When a stock’s price rises, the investor’s profits increase. Here are the current trends in margin trading.
1. Free Margin Trading
Today, many stock exchanges offer free margin trading to attract more clients and increase their market share. Free margin trading allows investors to borrow money from the broker and purchase shares without any initial cost or security deposit. Brokers hope that offering free margin trading will encourage investors to trade with them instead of competitors.
Free margin trading also means that an investor can increase his purchasing power without paying anything upfront or needing a large amount of collateral for him to secure the loan from the broker. However, this should be done with caution because borrowing money is a double-edged sword.
Although free margin trading is a good incentive for new investors, it should be used with caution because it can lead to significant losses due to volatility in the market. This may happen because of an unexpected event or a sudden change in the price of a stock. In this case, the investor will be left with insufficient collateral to cover his loan and sell off his shares at a loss to repay his loan.
This is why many stock exchanges are beginning to impose specific rules on margin trading, whereby investors who want to trade on margin will be required to deposit some money upfront and pay some fees. Although free margin trading may seem like an attractive offer, it should still be approached with caution when using borrowed money for investment purposes.
2. Digital Margin Trading
Digital margin trading is another form of margin trading that has been growing in popularity among investors. Digital margin trading allows investors to trade stocks using the leverage of their existing assets. For example, if an investor has a portfolio of $10,000 and he wants to trade on digital margin using his current portfolio, he can do so by applying for a loan from the broker. The loan will be used to purchase stocks, and the investor will have his stocks as collateral for a loan.
As per the experts at SoFi, “The rules for short selling with a margin account can get even more complicated than a traditional margin trade.” Digital margin trading differs from traditional margin trading because it does not involve any physical collateral such as real estate or equities. Instead, these assets are used as collateral for a virtual loan that the broker creates to provide more funds for trading purposes. In this way, digital margin trading can be considered an advanced form of free margin trading because it allows investors to trade with borrowed money without using physical assets as collateral.