When is Margin Not Margin?

[OldGrantonian 10]

I've been buying Dow stocks for about 2 years now, and doing OK considering the economic climate.

 

With the markets so low, I want to try trading with a margin account, using only Dow stocks for safety (initially).

 

I live in the UK. As preparation, I have set up a separate bank account in the UK to ensure that I can meet margin calls even if the prices of all my stocks drop to $zero.

 

I would be grateful if someone could answer the following question.

 

Scenario 1:

 

1) Assume that I open a margin account with $2,500 cash. I believe that this gives a "margin buying power" of $5,000.

 

2) I then buy $5,000 of stock.

 

3) Assume the stock doubles in value, and I sell all the stock.

 

4) According to all the web articles on margin, I make a profit of 4 times the initial cash outlay. Because I receive $10,000, but I only paid $2,500 in cash.

 

Scenario 2:

 

1) Assume that I open a margin account with $5,000 cash (double the amount of Scenario 1). This now gives a "margin buying power" of $10,000.

 

2) I then buy $5,000 of stock (as before).

 

3) Assume the stock doubles in value, and I sell all the stock.

 

4) As before, I receive $10,000.

 

So, my question is. Do I still make a profit of 4 times? Or is it only a profit of 2 times, because there was enough available cash initially to buy the stock?

 

In other words, does the broker take the entire $5,000 in cash out of my account? Or does he only take $2,500 cash and lends me the other $2,500?

 

I'm sorry if I've used a lot of words to ask one question, but I want to be absolutely sure.

.

[SIUYA 11]

  OldGrantonian said:

Scenario 1:

 

1) Assume that I open a margin account with $2,500 cash. I believe that this gives a "margin buying power" of $5,000.

 

2) I then buy $5,000 of stock.

 

3) Assume the stock doubles in value, and I sell all the stock.

 

4) According to all the web articles on margin, I make a profit of 4 times the initial cash outlay. Because I receive $10,000, but I only paid $2,500 in cash.

 

Scenario 2:

 

1) Assume that I open a margin account with $5,000 cash (double the amount of Scenario 1). This now gives a "margin buying power" of $10,000.

 

2) I then buy $5,000 of stock (as before).

 

3) Assume the stock doubles in value, and I sell all the stock.

 

4) As before, I receive $10,000.

 

So, my question is. Do I still make a profit of 4 times? Or is it only a profit of 2 times, because there was enough available cash initially to buy the stock?

 

In other words, does the broker take the entire $5,000 in cash out of my account? Or does he only take $2,500 cash and lends me the other $2,500?

 

I'm sorry if I've used a lot of words to ask one question, but I want to be absolutely sure.

.

 

you have switched what you are comparing in the two scenarios.

1....you are using the base of the margin requirement to calculate your PL multiple

2....you are using the amt deposited with the broker to calculate your PL multiple.

 

which leads to your next question.....

the answer here is it depends on the broker, and the type of account.

I would say that generally if you are buying on margin then yes the broker will wish to lend it to you (this maximises their profit in general), whereas with a cash funded account there is no lending.

Think of it this way - you can borrow from the broker, with in the account, OR you can borrow from a third party before depositing with the broker.

 

there are many ways to do this and you need to understand which your broker does as it can greatly affect the costs over the long term.

[Tams 20]

  OldGrantonian said:

I've been buying Dow stocks for about 2 years now, and doing OK considering the economic climate.

 

With the markets so low, I want to try trading with a margin account, using only Dow stocks for safety (initially).

 

I live in the UK. As preparation, I have set up a separate bank account in the UK to ensure that I can meet margin calls even if the prices of all my stocks drop to $zero.

 

I would be grateful if someone could answer the following question.

 

Scenario 1:

 

1) Assume that I open a margin account with $2,500 cash. I believe that this gives a "margin buying power" of $5,000.

 

2) I then buy $5,000 of stock.

 

3) Assume the stock doubles in value, and I sell all the stock.

 

4) According to all the web articles on margin, I make a profit of 4 times the initial cash outlay. Because I receive $10,000, but I only paid $2,500 in cash.

 

Scenario 2:

 

1) Assume that I open a margin account with $5,000 cash (double the amount of Scenario 1). This now gives a "margin buying power" of $10,000.

 

2) I then buy $5,000 of stock (as before).

 

3) Assume the stock doubles in value, and I sell all the stock.

 

4) As before, I receive $10,000.

 

So, my question is. Do I still make a profit of 4 times? Or is it only a profit of 2 times, because there was enough available cash initially to buy the stock?

 

In other words, does the broker take the entire $5,000 in cash out of my account? Or does he only take $2,500 cash and lends me the other $2,500?

 

.

if you buy on margin, the broker takes $2,500 from your account and lends you $2,500. The rest of the cash in your account is on standby... for you to purchase MORE stocks, so that the broker can lend you MORE money.

[OldGrantonian 10]

Many thanks to SIUYA and Tams for their helpful responses

 

It seems to me that both are saying the same thing.

 

SIUYA says:

 

  SIUYA said:

which leads to your next question.....

the answer here is it depends on the broker, and the type of account.

I would say that generally if you are buying on margin then yes the broker will wish to lend it to you

 

Tams says:

 

  Tams said:

if you buy on margin, the broker takes $2,500 from your account and lends you $2,500.

 

I think both are saying that if I have a MARGIN account with $1,000,000 in cash, then my "margin cash available" is $1,000,000, and my "buying power" is $2,000,000.

 

If I now buy $10 of stock, the broker takes $5 in cash and lends me the other $5. (I'm deliberately using ridiculously high and low values.)

 

This is the way that I would want my MARGIN account to operate. Because I think the market is low, I want to use margin for upside leverage, not because I need to borrow money. (As I said in my original post, I'll make damned sure in advance that I can meet any margin calls right down to zero.)

 

However, I was waiting quite a long time for a reply on this forum, so I made an identical post to:

 

When is margin not margin? - Trade2Win Forums

 

The reply was from John Forman, who wrote "The Essentials of Trading".

 

He says that if there's enough cash to buy the required stock WITHOUT margin, then the broker takes out the cash, and lends you nothing. And that's exactly what I DON'T want.

 

So, with the greatest respect, it seems to me that SIUYA and Tams are agreeing with each other, but disagreeing with John Forman.

 

Maybe I'll experiment by opening a margin account with a tiny amount, say $500, then buy $100 of stock to see what happens. (My broker says I can open a margin account any time.)

 

Thanks for all the help

[SIUYA 11]

as mentioned before - it all depends on the broker and type of account you are dealing with.

If its a swap account (spread bet/margin account), i would bet the broker is generally trying to lend you the money and charge you for it.

If its a cash account with margin - when and if required, then they may only take out margin when you then need it.

The broker should be able to give you worked examples.

....and personally I would always wish to use my own cash first rather than a brokers - they will pay you 3% on your cash balances and lend to you at 5% - so why not maximise your broker balance first before borrowing