You have probably heard of margin lending as a part of a trading strategy. However, you may still have some doubts as to whether or not you should use it. In this article, we’ll break down the definition of margin lending and lay out some of its risks and benefits for you to weigh, so that you can make an informed decision on your trading journey.
What is margin lending?
To put it simply, margin lending is a type of loan that allows you to borrow money to invest. If you have ever used leverage, you will have heard of the term ‘margin’, which is your deposit in opening a larger position than you would have otherwise been able to ‘afford’ by borrowing capital from your broker or bank.
Margin lending uses your existing shares, managed funds, and (or) cash as a sort of security, and the amount you are allowed to borrow is based on your financial security, which is determined by your broker or bank.
How margin lending works
One of the most important things that is reviewed when you want to apply for margin lending is your Loan to Value Ratio (LVR) of your existing portfolio. This is the amount of the loan you want to take out divided by the value of the shares used as security.
If the value of your security suddenly takes a dip and becomes much lower in relation to your loan amount, it is possible that you will exceed your LVR, which will cause your bank or broker to issue you a ‘margin call’. In this situation, you will have to reduce your loan amount or increase your security amount until your LVR is up to a certain level again.
Therefore, when you are using margin lending, you should be aware of your investments more than usual, and you should ensure that you understand what you are getting into.
Who is margin lending for?
Margins are suited for almost all traders if they understand clearly how they work. The most common examples of people who take out margin loans are corporate executives, business owners, real estate developers, and other investors who often prefer to open large positions.
With large dealings, there is also a potential for greater flexibility in the terms and conditions of the loan, as well as reductions in borrowing costs and savings in taxes. Therefore, they are a very popular option for those who already have large amounts of capital in their account and are looking to bridge liquidity issues momentarily.
Risks of margin lending
Margin lending’s biggest risk is the fact that you, as a trader, will be borrowing money to invest. Like the use of leverage in, say, CFD or listed options or forex trading, you are essentially opening a position that is bigger than your actual capital, which means that if you happen to lose money, you may end up incurring losses greater than your initial investment.
You should always remember that you will still have to pay back the loan at the end of the day, and therefore never to take margin lending lightly, as you will be taking the risk of borrowing and the risk of losses.
Benefits of margin lending
With that said, margin lending remains a popular choice for a variety of reasons, and below we will outline some.
Firstly, margin lending’s greatest benefit is that you can increase your investment exposure. With the help of a loan from your broker or bank, you can open a position that is much greater than that of what you would be able to do if you were just trading by yourself, with your own capital. This is hugely appealing as a bigger position means a bigger potential for profit when markets move in your favour.
Secondly, margin lending can also have tax benefits depending on where you are located. For example, traders may be able to claim the interest on these loans as a tax deduction. However, for a detailed overview of local regulations, Dutch traders should always check out information from their local monetary authority. Additionally, different brokers may have different fees and charges associated with margin lending that traders should be aware of.
Get started with margin lending in the Netherlands
If you are located in the Netherlands, you can contact a reputable broker to help you get started with margin lending. For more information, you can visit Saxo NL.