What does it mean to trade on margin?
Trading on margin means borrowing money in order to carry out trades. When trading on margin, investors first deposit cash or their portfolio of shares that serves as collateral for the loan and pay ongoing interest on the funds they borrow. This loan increases the buying power of investors thereby enabling them to buy a larger quantity of securities. The securities so purchased automatically serve as collateral for the margin loan.
Increased returns
The most significant advantage of using margin is the ability to leverage your investments and increase returns when the prices of your holdings are moving in your favor. The power of leverage in a rising market is explained by the following example – You have LKR 20,000 worth of securities bought using LKR 10,000 borrowed and LKR 10,000 of your own funds i.e., equity. Say the market value of these securities rises by 25% to LKR 25,000 in the month following the purchase and the amount you have borrowed remains same at LKR 10,000. Thus, at the end of the month your equity would have increased to LKR 15,000. That means your equity grew from LKR 10,000 to LKR 15,000, a growth of 50% in the month following the purchase of the securities.