A margin account is a type of brokerage account that lets you speculate on the price movements of securities through buy and sell positions with borrowed funds, allowing you to magnify your profit or loss. A margin account only requires you to pay a fraction of the position’s full value, known as your deposit, and you essentially borrow the rest of the funds from the broker.
Margin accounts work by offering leverage to traders to gain increased exposure to the financial markets. With a margin account, you can open a buy or sell position depending on whether you think that the value of a security will increase or decrease. The ability to participate in short selling when asset prices fall is an attractive aspect of margin trading for those who don’t want to buy and hold securities for a long period of time.
At CMC Markets, we offer two types of account that you can use to trade on margin: a spread betting account and a CFD trading account.
Spread betting is a popular derivative product that allows you to trade tax-free* in the UK. After opening a spread betting account, you can speculate on the underlying price movements of over 10,000 financial assets using leverage, including stocks, forex, commodities, bonds and indices. With spread betting, you buy or sell a pre-determined amount per point of movement for the asset that you are trading, which is known as your spread bet 'stake'. For every point that the price moves in your favour, you will make a profit; however, you will make a loss for every point that the price moves against you.
CFDs (contracts for difference) are another type of derivative product that describe a short-term contract between an investor and broker. Similar to spread betting, you don’t own the underlying asset. Instead, you buy or sell a number of units for a particular financial instrument, depending on whether you think its price will rise or fall. At the end of the contract, the parties exchange the difference between the opening and closing prices. CFD trading also involves the use of leverage, which gives you wider exposure to the markets, but can magnify both your profits and losses, as these are based on the full value of your position. Read more about leveraged trading.
The two main types of brokerage accounts use margin and cash. Whereas a margin account allows traders to borrow money to in order to buy or short sell leveraged securities, a cash account requires that all transactions must be paid upfront, which are most often long (buy and hold) positions.
With a margin account, you can speculate on bull and bear markets depending on your strategy, only having deposited a small fraction of the trade’s original value. On the other hand, investors that are purchasing securities with a cash account must settle the buy order with a cash deposit, or they can sell an existing position on the same trading day.
There are pros and cons for both types of trading account, and this depends on your overall trading strategy and goals, whether they are short or long-term, and whether you have the funds readily available to pay upfront. Typically, a margin account is preferred for short-term trading, whereas a cash account is more suited to medium or long-term investments, such as pensions.