how do YOU use margin?

Discussion in 'Trading' started by Gordon Gekko, Aug 20, 2002.

  1. before i start, i'd like to make it clear that i'm not necessarily talking about intraday trades. i'm talking about swing trades or an even longer time frame.

    that being said, how do you guys use margin? do you hold more positions or do you make each position size larger?

    for example, say you have 100k cash and 200k buying power using margin. not using margin, you might have 10 positions about 10k each. if you used margin, would you still have 10 positions but double the size (20k each), or would you have 20 positions at 10k each? or some other method?

    just curious...thanks.
     
  2. regough

    regough

    Don't use it, personally- never liked the stuff anyhow. I suppose that is part of my risk control philosophy. (of course, I have to have a margin account just so I can short :) ) but otherwise try to avoid it (in trading and everything)
     
  3. It's kinda like wearing a jock strap while playing fuzball(the waterboy), you wanna protect the family jewels.
     
  4. I use margin in two ways:

    1) My swing trading system looks for stocks that have "fallen too much" so that I can expect a profitable bounce. Depending on the stock and prior price action, the definition of "fallen too much" may be anywhere from 3% to 50% below the prior end-of-day closing price. I use the buying power of the margin to be ready to take advantage of more stocks dropping in the rare event that a large number of stocks fall a great deal. Margin buying power lets me both increase the number and increase the size of my swing-trade positions.

    2) I have also started hedging my multiple long positions with a corresponding short position in the index (I swing-trade N100 stocks with long positions and short QQQ). By buying stocks with a high expectation of relative strength and selling the index, I hedge the market move (which I do not know how to predict yet). The goal is to reduce the beta of my trading system to near zero (although I do increase my random risk somewhat in the event that my long stock position drops at the same time that the index rises). The short selling requires a margin account and can involve margin borrowing if the combined long and short positions are large enough.

    That said, I really use margin as buying power to be used very sparingly (actual borrowing on margin is for rare opportunities like the post 9/11 dip). I look at trading like a control theory problem where my buying power represents the limits of my range of control. If I have no remaining buying power, then I have no remaining control in the event of a future buying opportunity. If I have no remaining shares, then I have no remaining control in the event of a selling opportunity. Less that 5% of my trades dip into margin and I have never come close to using all the buying power available to me (in either real or backtested trading).

    <b>Caution: Margin Amplifies Downside</b>

    One caution is that margin borrowing can turn a seemingly profitable trading system into a loser. Margin borrowing has an asymmetric amplification effect on trading system returns. With no margin, a 10% drawdown from a string of losses can be offset by an 11.1% gain from a string of wins. With 2:1 margin, a 10% drawdown from a string of losses requires a 12.5% gain from a string of wins. To see this, imagine borrowing 100k on a 100k cash position for 200k buying power. A 10% drawdown turns the 200k into 180k, leaving you with 80k after paying back the borrowed 100k. That 80k lets you borrow only 80k for 160k of buying power for the next set of trades. A 12.5% rise on the 160k gets you to 180k. Paying back the 80k borrowed puts you back to the 100k cash level that you started with. If you use 4:1 margin (IB lets you do this), then a 10% drawdown requires a 16.7% gain to offset the losses. Although I have described this example in terms of needed gains to offset a loss, the numbers are identical if you have the gain first and then the loss (e.g., at 4:1 margin, a 16.7% gain gets killed by a subsequent 10% loss). (Oh yeah, trading on margin is actually worse than I have portrayed because you also have to pay interest on the borrowed money)


    The point is, I try to be very careful with leverage of any kind.

    Happy trading,
    -Traden4Alpha
     
  5. "A 10% drawdown turns the 200k into 180k, leaving you with 80k after paying back the borrowed 100k. That 80k lets you borrow only 80k for 160k of buying power for the next set of trades."


    I'm not sure that I agree with this logic. Wouldn't it make more sense to say that a 10% drawdown on a $100,000 account = $90,000? I don't see how the use of margin affects this basic formula. I'm sure most people calculate their % wins and losses based on their account value, not their overall buying power.

    I'm not arguing that margin generated losses aren't bigger and more difficult to recover from, I'm just thinking that the above statement might be misleading...

    Personally I have no problem using margin. The trick is to be responsible. If each position and your accont reflect an acceptable risk level then trading on margin shouldn't be a problem. When I started trading a few years back I experienced the joys of margin calls. Those love taps taught me more about the "double-edged sword" than any text book ever could have.

    Anyway, to the person who started this thread - I'm not sure if you're a newbie or not. But if you're not sure whether to use margin, then use it sparingly. People who juggle knives for a living don't learn using sharp ones.
     
  6. Rigel

    Rigel

    There is at least one circumstance in which it isn't prudent to use margin. Scalping and margin don't go together. A trading halt with a 50% gap in the wrong direction on a single full account position at 5:1 margin could put you out of the game and into huge debt in the blink of an eye, and it will happen sooner or later. Scalping single positions with margin is very unwise IMO.
     
  7. OK, I can see where this can get confusing. Lets pretend that we are swing trading a stock and our first trade goes well (gaining 15% on a nice upswing), but our second trade goes poorly (losing 10% on an overnight price drop). So how'd we do? Well, lets say we have two traders entering the same swing trades for the same 15% gain on the first trade, 10% loss on the second trade.

    <b>Trader 1: No Margin (Conservative)</b>

    Trader 1 buys 100k in stock on the first trade, rides the 15% upward swing and receives 115k. Then, trader 1 buys 115k in stock on the second trade, hits the 10% drop and sells it for 103.5k. For trader 1, the 15% gain followed by a 10% loss will net out to a 3.5% gain on the original 100k invested.

    <b>Trader 2: 4:1 Max Margin (Aggressive)</b>

    Trader 2, being ultra aggressive, borrows full margin for the two trades. So, Trader 2 buys 400k (100k cash + 300k borrowed) in stock on the first trade, rides the 15% swing and receives 460k. After paying back the 300k in borrowed margin, Trader 2 is left with 160k (WOO HOO!). Trader 2 then buys 640k (160k cash + 480k borrowed) in stock on the second trade, hits the 10% drop and sells it for 576k. After paying back the 480k in borrowed margin, Trader 2 is left with 96k. For trader 2, the 15% gain followed by a 10% loss will net out to a 4% loss on the original 100k invested.


    Moral of the story: Although margin does amplify the gains, it amplifies losses even more.

    I hope the example shows you what I mean (or perhaps someone can help me find the error of my ways?),
    -Traden4Alpha
     
  8. tntneo

    tntneo Moderator

    margin here is only in the context of swing trades (no daytrading, no futures margin which is something different).

    margin is really a disaster waiting to happen before you are hit with a losing streak.
    when it happens the proper reaction imo is to reduce size very quickly (of course no margin anymore). some would disagree with that, but that's what I do.

    the bad, bad, bad idea is to use margin when you are in trouble (losing streak or to average down).

    margin amplifies losses more than wins. when in a winning streak, increase size (or number of pos). when in a losing streak, reduce drastically. then you should be fine.

    tntneo
     
  9. CalTrader

    CalTrader Guest

    Excellent posting by Traden4alpha .....

    I approach margin in a way which is similar to Traden4Alpha's view. In our models, margin is viewed as another risk parameter: it is coupled to other risk parameters. The point is that we generally view margin as something to be minimized since under certain circumstances it can greatly enhance the risk of a particular trade.
     
  10. If trader 1 buys $100,000 worth of stock each time, he will net $5,000.

    If trader 2 buys $400,000 worth of stock each time, he will net $20,000.

    There are lots of different ways to look at using margin, and money management is always very critical.

    Whenever position size is increased, there is the risk of a loss - amplified by the new larger size - destroying previous profits. Conversely, a profit amplified by the new larger size could make up for a previous loss (although I wouldn't recommend increasing position size when you are losing). This is true whether margin is used or not. This is one of the reasons I try to increase my position size gradually.
     
    #10     Aug 20, 2002