Leverage a Position while Day Trading in Stock and Bond Markets
Leverage is the use of borrowed money to increase returns. Day traders use leverage a lot to get bigger returns from relatively small price changes in the underlying securities. And as long as they consistently close their positions out at the end of the day, day traders can borrow more money and pay less interest than people who hold securities for a longer term.
The process of borrowing works differently in different markets. In the stock and bond markets, it’s straightforward: When you place the order, you just tell your broker you’re borrowing. In the options and futures markets, the contracts you buy and sell have leverage built in to them. Although you don’t borrow money outright, you can control a lot of value in your account for relatively little money down.
Leverage is straightforward for buyers of stocks and bonds: You simply click the box marked “Margin” when you place your order, and the brokerage firm loans you money. Then when the security goes up in price, you get a greater percentage return because you’ve been able to buy more for your money. Of course, that also increases your potential losses.
The trader borrows money to buy 400 shares of SuperCorp. If the stock goes up 4 percent, she makes 8 percent. Whoo-hooo! But if the stock goes down 4 percent, she still has to repay the loan at full dollar value, so she ends up losing 8 percent. That’s not so good.
If you hold your margin position overnight or longer, you have to start paying interest, which cuts into your returns or increases your losses.