Day trading versus mutual funds. Two very different ways of investing money. Which one is…
Like anything involving the financial market, being a day trader includes a fair amount of risk. A day trader is generally an individual who completes or closes all his or her transactions before the market closes for the day. What that means is a lot of transactions need to occur, and usually for a minimal amount of profit gain. Ideally, this minimal profit will multiply several times over by doing numerous transactions throughout the course of the day.
By adopting a strategy, sticking with it, and being disciplined enough to ride out the market’s volatility day traders can have a reasonable amount of success over the long term. This success, however, may not translate into a large amount of money. In order to make more money, usually you need to invest more.
Day traders who work at a financial institution and have access to large amounts of capital are able to maximize their profits by investing large sums of money, which if successful will produce large amounts of profit, even if there is only a small percentage of increase. Naturally, there is a greater risk with a greater amount of money being invested, and this is a consideration that needs to be taken into account.
For a day trader who works for himself or with only a couple of other traders, there is an option to increase the amount of money he has available to invest: borrow it.
In a perfect situation, the day trader could borrow a large sum from a bank, invest it successfully, and then pay back the loan and any accumulated interest, and keep the profits earned. The risk is if the investment is not successful.
The day trader may not necessarily have to pay back any money lost immediately. If that is the case, then he could continue to invest the remaining amount of capital, hopefully be successful this time around, and then be able to pay back the loan and keep whatever profit remained after interest.
What makes things especially difficult is the margin call. When a financial institution makes a significant loan to a client for investment purposes, often that money is put into a margin account. If a margin account has been set up, then there will be a minimum amount of money that must remain in that account. Generally, this amount is 50% of the stock’s value, though it could be even lower.
If the amount in the account dips below the agreed-upon percentage, then a margin call can be made, where the lender can demand that the amount be topped up to meet the minimum percentage. This would have to be done by selling stocks or contributing other money from the investor’s own assets.
So if the margin call is at 50% and the amount borrowed is $100,000, if the funds in the account drop to $25,000 the investor is required to put another $25,000 in the account to build back up to 50%. This could very well be money that the investor does not have, which can have devastating consequences.
The plus side of borrowing on the margin for day traders is that there are usually only charges of interest after each day. Meaning, that if the loan is returned before the market closes, there would be no fees that the day trader has to pay, allowing him to invest a significant amount of money, earn a quick profit, and then return the principle.
The risk of a margin call is a significant one, but day traders who are disciplined and have strong money management skills are often able to successfully work with these large sums of money.