Trading with margin is the basic idea that you are trading with more cash than you have on hand. The key with margin is learning to manage your risk exposure at any given time. The use of margin is not something advised for a new trader or a trader that is unable to produce consistent gains in the market. In this article I will cover my own strategy for how to day trade with margin.
Trading with margin is an activity that you must have a close eye on. You want to watch these positions closer than your 2 year-old son walking through a crowded mall. When day trading you have up to four times your available cash at your disposal. This allows a person with a much smaller account to trade like one of the big boys. I know what you are thinking, day trading with margin is better because I can just use more money? Wrong! Day trading with margin is better because the sheer act of day trading requires you to pay close attention to your trading activity. Unlike swing traders who may be hit with overnight news or the macroeconomic event of the day, you the day trader are lock step with your position every tick of the way. You are forced to actively manage your margin because you are actively managing your position. This reduces the likelihood of significant price fluctuations that could wreak havoc on your trading account.
Ability to Scale up or Down on a dime
When you are winning in the market you honestly begin to feel like Michael Jordan during any one of his 6 championship runs with the Bulls. It feels like no matter what kind of trade you put on, you will come out on top. Well any successful trader well tell you in this business when you are winning it is the time to press the gas and when you are not doing so well, you need to tighten the belt. The ability to increase and or reduce your risk profile on a dime is often the difference between an average and above average trader. For example, let’s say you were short 200% on a stock and plan to hold your position for one year. However, around month 9 you realize you are now down 50% on your account from over leveraging yourself. Do you simply cover your position? You could, but what do you do at that point. Do you now use more margin to make back what you have loss? Or do you use less money because you haven’t proven to yourself you know what you are doing? If you reduce the amount of margin you can use, this could triple the time required to get back to breakeven. Do you see how painful this thought process can be? Day trading allows you to work through these cycles of using more or less margin on a weekly and even at times daily basis. Let’s replay that same sort of scenario but let’s use a day trader in this example. Bob has loss money for 5 trading days in a row. He feels like he can’t find his way and is down 10% on his account value. Bob decides to reduce his trading size down to his available cash until he is able to recoup his losses. This takes Bob 3 weeks and before he can blink he is right back to trading with ease.
How do things get out of hand?
So, at this point you are probably asking yourself, well if using margin with day trading is so great why do people struggle so much. I have already stated that day trading allows you to (1) have laser focus on your trading and (2) quickly adjust your use of margin based on your trading activity. So why do so many lose? Simply put, just as much control day trading allows you to have over your activity; it can also lead to over trading.
As long as you meet the day trading requirement of at least $25,000 dollars in your account balance, you can place as many trades as you like in a given day. This ability to place so many trades if left unchecked can prove disastrous for someone going through a rough patch. Combine the ability to place unlimited trades with up to four times margin, well I think you get the point.
My Personal Strategy for Day Trading with Margin
Now that we are done with the narrative, let’s dive into the hard fast rules which work for me:
Only use margin once you have been able to turn a string of monthly profits for 3 straight months day trading.
Only use 10% of available margin on any one trade. So, if you have 250,000 cash or 1 million on margin, only use $100,000 per trade.
Only hold 3 trades at-a-time. This way in the above example your maximum exposure would be $300,000 dollars or 20% above your available cash.
Never lose more than 2% of your available cash on a trade. That would translate to a maximum loss of 2.5% on any trade.
Never hold a position overnight. If you are day trading, then do just that – trade during the day.
If you have a losing week, reduce the amount of margin by 25%. Continue this reduction in a linear fashion until you turn a profit for the week. Use this same approach to stair step back to the maximum use of margin. For example, if you have a losing week, reduce your margin use from $100,000 down to $750,000. If you have another losing week, then drop this value down another $500,000. Once you get down to your cash balance of $250,000 drop it by 25% of this value week over week. I guarantee you as you reduce the amount of money available for you to trade, your level of focus on making money will increase and you will turn a profit. There is no greater motivator than that of sheer survival.
Crawl Before you run
The accessibility to margin provides the illusion of endless wealth right within your grasp. If left unchecked you will actually begin to feel a sense of attachment to the money as if it’s your own. In reality margin is the equivalent of placing a deadly weapon in an untrained hand. You must treat it with such care that the fear of what it can do to you both professionally and personally should always keep the relationship in a constant state of flux.