This is not investment advice. The information provided is for educational and informational purposes only and does not constitute a recommendation to buy or sell any financial product.
A margin trading account is a brokerage account that allows the trader to borrow against the cash and securities in the account to take leveraged positions. The mechanics are the same as any other leveraged account: the trader puts down a deposit, the broker lends the rest, and the trader's equity is the difference. The management is what separates the trader who survives a volatile market from the trader who is wiped out by a margin call.
The four numbers to watch
The first number is the account equity. The equity is the cash plus the market value of the securities, minus any borrowed amount. The equity is the trader's real wealth in the account, and the equity is what the broker looks at when calculating the maintenance margin. A trader who has €10,000 of equity in a margin account has €10,000 to lose before the account is at the maintenance margin.
The second number is the maintenance margin. The maintenance margin is the minimum equity the trader must maintain as a percentage of the leveraged position value. For a major US stock, the maintenance margin is often 25%. A trader with a €20,000 leveraged position must maintain at least €5,000 in equity. When the equity falls below €5,000, the broker issues a margin call.
The third number is the cash buffer. The cash buffer is the cash in the account that is not committed to a position or to a margin requirement. The cash buffer is the trader's defence against a drawdown, and the cash buffer should be 10% to 30% of the account value, depending on the volatility of the holdings. A trader with a larger buffer can absorb a larger drawdown without triggering a margin call.
The fourth number is the drawdown limit. The drawdown limit is the maximum percentage loss the trader is willing to accept on the account before reducing the position size or closing the account. A common rule is a 20% drawdown limit. A trader who hits a 20% drawdown stops trading, reviews the strategy, and only resumes when the strategy is fixed.
The discipline of position sizing
The most important discipline is position sizing. The position size on every trade is set by the dollar risk at the stop, not by the desired return or the available leverage. The trader calculates the distance from entry to stop, multiplies by the share count, and sets the dollar risk at 1% of the account. The position size is whatever produces that dollar risk.
A trader who uses this discipline consistently produces a return that is consistent with the strategy's win rate and risk-reward ratio. A trader who uses leverage to take a position larger than the discipline allows produces a return that is dominated by the largest loss, and the largest loss is the one that wipes out the gains from the smaller wins.
The discipline is the same in a margin account as in a cash account, but the stakes are higher. A 1% loss on a margin account is a 1% loss on the equity, not on the position value. A 10% loss on a 5:1 leveraged position is a 50% loss on the equity, and a 50% loss on the equity requires a 100% gain to recover. The discipline of position sizing is the only way to make the leverage work in the trader's favour.
The discipline of cash buffer
The second discipline is the cash buffer. The cash buffer is the cash in the account that is not committed to a position. The cash buffer absorbs the drawdown, and the buffer is the difference between a tradable drawdown and a margin call. A trader with a 20% cash buffer can absorb a 20% drawdown on the leveraged positions without triggering a margin call. A trader with a 0% cash buffer is exposed to a margin call on the first drawdown.
The buffer is not free. A 20% cash buffer on a €50,000 account is €10,000 of cash that is not invested, and the opportunity cost is the return on the €10,000. The opportunity cost is real, and the trader should weigh it against the cost of not having the buffer. The compromise is to hold a smaller buffer in calm markets and a larger buffer in volatile markets.
The discipline of the exit plan
The third discipline is the exit plan. The exit plan is the set of rules that determines when a position is closed. The most common rules are a stop loss at a defined price, a take profit at a defined price, and a time-based exit at a defined date. The rules are set before the trade is placed, and the rules are honoured when the price reaches the level.
The exit plan is the trader's defence against the behavioural trap. A trader who is up on a position is reluctant to take the profit, because the return feels too small for the leverage. A trader who is down on a position is reluctant to take the loss, because the loss feels too large for the trade. The exit plan is the pre-commitment that overrides the behavioural trap, and the pre-commitment is the only way to make the discipline work.
The discipline of the review
The fourth discipline is the review. The trader reviews the account at a regular cadence (weekly or monthly), and the review is a structured assessment of the strategy, the discipline, and the performance. The review is the opportunity to identify the trades that worked, the trades that did not work, and the trades that were outside the discipline. The review is the basis for the next month's trades.
The review is also the opportunity to adjust the position size, the cash buffer, and the drawdown limit. A trader who is consistently hitting the drawdown limit should reduce the position size. A trader who is consistently producing a positive return should increase the position size, but only after a track record of six to twelve months.
Related resources
Where to start
If you are managing a margin account, the most useful exercise is to set the four numbers, and to monitor them on a weekly basis. Our broker comparison lists the margin policies and the maintenance margin at each broker, which together tell you what the discipline needs to look like for your account.