Friday, 26 December 2014

Selection of online brokerage: Margin Financing

This post is an extension of my previous post:

There are many reviews out there on various online trading platforms. If you are taking a long term approach to investment, it will be relatively easy to choose one.

However, if you are going to be trading instead of investing and holding for the long haul, you will probably need some margin financing or a margin trading account. There are many margin financing options for you to choose from whether you are located in Singapore or other parts of the world.

Specifically in Singapore, a quick search of the term "Margin Trading Account" on Google reveals that major banks like DBS, OCBC and UOB provides such facilities for their clients. So what is margin financing? Simply put, it is using the cash or securities/ shares in your trading account as collateral for increasing your purchasing power (i.e. borrowing money from your broker). It is also known as leverage.

Example: Normally if you wish to buy 1,000 shares of "A" priced at $10 per share, you need to have $10,000 in your account to finance the purchase. However with margin financing, if the margin for the purchase of share "A" is 10%, you will only need $1,000 in your account to buy these 1,000 shares.

Sounds great? Only if the trade went your way. Both winnings and losses will be magnified accordingly to the margin rate. This is why you have to be careful when taking on margin for trading, as you can get a margin call if the value in your account falls below your maintenance margin (i.e. the collateral, cash or securities are not sufficient to cover the money you have borrowed from your broker).

If you do your analysis well enough, and you are confident of the direction of where prices will be headed, then margin financing could definitely benefit you. My advise is that you only take on margin trading when you have mastered various indicators and signals that result in price changes, be it fundamental or technical. Personally, my trading account had taken a few hits due to trading on margin as I was somewhat ignorant when I started utilizing margin financing.

So what else do you need to watch out when using margin financing?

1. What is the interest rate for margin financing (sometimes known as overnight premium)? Remember you are borrowing money from your broker, so you have to pay interest. This is also why margin financing is not exactly suitable for buy and hold investor as interest will eat into your gains.

2. What is the leverage ratio or margin rate allowed on various securities? From what I gather, brokers are more willing to provide a higher leverage for shares that are less risky (e.g. like blue-chips stocks).

3. How long is the interest free period? While some brokers charge interest as long as you financed your shares purchase with margin, others allow an interest free period. This is very useful for swing traders! E.g. Maybank has a 7 days interest free period and UOB Kay Hian provides a 10 days interest free period. Normally, I don't hold beyond 10 days anyway, so essentially it is considered "free" margin for me.

I hope this post is useful for you if you are considering applying for a margin trading account. Feel free to leave a comment.


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