Trading on margin allows you to buy stocks with a little bit of your own money and a lot of someone else's. When you profit, those profits are amplified, because you're making money off of your money and the money you borrowed. But when you lose money, those losses are amplified too.
For an example of the towering heights and plunging depths that can come with trading on margin, consider the investor who built up a $415 million portfolio and lost it all in the span of 3 years.
Below is a guide to how margin trading works, how it can go wrong, and the most common mistakes margin traders make. Understanding these pitfalls can help you approach margin with a clearer head and a stronger plan.
What is margin trading?
Margin trading is a strategy where you borrow money from your brokerage to buy investments, using your existing holdings as collateral. Instead of paying the full price of a stock or exchange-traded fund (ETF) with your own cash, you put up a portion — called the initial margin — and your brokerage lends you the rest.
A margin account is different from a cash account, where every purchase must be fully funded with your own money. With a margin account, you get additional buying power — but you also take on additional risk, because you owe the borrowed amount back regardless of how your investments perform.
Two key thresholds matter in a margin account:
Initial margin: the percentage of a trade's value you must fund with your own money when opening a position
Maintenance margin: the minimum equity you must keep in your account at all times. If your account falls below this level, your brokerage may issue a margin call
How margin amplifies gains and losses
Suppose you have $5,000 in your account and your brokerage lets you borrow an additional $5,000 on margin. You invest the full $10,000 in a stock.
If the stock rises 20%: your $10,000 becomes $12,000. After repaying the $5,000 you borrowed, you have $7,000 — a $2,000 profit on your original $5,000. That's a 40% return, double what you'd have earned without margin.
If the stock falls 20%: your $10,000 becomes $8,000. After repaying the $5,000 loan, you're left with $3,000 — a $2,000 loss, or 40% of your original investment. Without margin, you'd have lost only $1,000.
And that's before accounting for the interest you pay on the borrowed money, which eats into gains and deepens losses.
Mistake #1: Not understanding how margin trading works
This one may seem obvious, but it's worth including. A lot of people see the chance to boost profits and dive in without completely understanding the mechanics — how margin calls work, how interest is charged, or how quickly losses can snowball. If you're reading this, you're already ahead of the curve.
Mistake #2: Not managing your risk
Margin lets you deploy capital more efficiently than traditional investing. You can use leverage to invest more than $100 for every $100 you have in your account — but in what are possibly the words of Voltaire (and what are definitely the words of Uncle Ben in Spider-Man): with great power comes great responsibility.
Not only do you need to be aware of how you're allocating your money, you also need to pay attention to how you're allocating risk. That's good advice for all investors, but especially for margin investors, since you can much more easily erase your wealth.
Mistake #3: Taking on too much risk
Some stocks and leveraged exchange-traded funds (ETFs) are already very volatile. When you trade them on margin, you're cranking up that volatility.
Let's say there's a stock, $LOON, that has a volatility of 60%. That means it's not unusual for its price to jump or fall by nearly two-thirds at any given time. You're already in high-risk, high-reward territory simply by investing. Adding margin to the mix may not be the wisest move.
Mistake #4: Forgetting that volatility can change
Like its price, a stock's volatility can change at any time. Since the amount of money you can borrow in a margin account is based on the volatility of the stock you're buying, a sudden change in volatility would mean a sudden change in capital requirements — not to mention a change in the riskiness of your portfolio.
If you don't have a cushion in your account, you'll need to deposit more cash or other assets when this happens. Otherwise you could be on the receiving end of a margin call. That may involve your brokerage liquidating your position to make sure they get their money, forcing you to realize losses you may not have been prepared for.
Mistake #5: Thinking asset prices will always go up
Markets have periods where they get hot. It's easy to get caught up in that kind of success and convince yourself to keep rolling any profits you make into more margin positions.
But don't let the excitement fog your memory: the good times don't last forever. Bull markets always go bear-shaped. If you're investing like that's never going to happen, your wake-up call could be very expensive.
Mistake #6: Getting too speculative or emotional about your trades
In any kind of investing, you want to have a strategy and stick to it. That's especially true of margin, when even more is on the line.
Greed or fear can push you to make rash decisions, and the potential negative impact of those decisions is amplified as much as your returns could be. Be deliberate with what you're investing in. Get out when you plan to get out, and don't throw good money after bad.
Mistake #7: Investing in low-returning assets
This is a big one that a lot of people overlook: you're charged interest on the money you borrow on margin, which means you need your investment to outperform that interest rate.
Typically, you don't want to leverage an investment in something with an expected return of 5% when you're paying 7% to do it. You can actually make less than you would have had you not used margin at all.
How to reduce your margin trading risk
Margin trading doesn't have to end badly — but it does require more attention than a standard cash account. Here are some ways to keep your risk in check:
Keep a cash cushion: maintain extra cash or liquid assets in your account so a sudden price drop doesn't trigger a margin call
Use stop-loss orders: set automatic sell points to limit how much you can lose on any single position
Diversify your holdings: concentrating your borrowed capital in a single stock multiplies your risk. Spreading it across multiple positions can soften the impact of any one loss
Monitor your positions regularly: margin accounts need active oversight. Check your maintenance margin and account equity frequently — especially during volatile markets
Borrow less than your maximum: your brokerage may offer you a certain amount of leverage, but that doesn't mean you should use all of it
