Margin accounts in Canada are typically used for leverage. Margin account allows investors to borrow money to trade more stocks or other assets. Thus, a 10% profit or loss on a stock will result to around 20% profit or loss when margin is used.
Using margin enhances the profit or loss returns on a stock since more money is invested when borrowing money.
For example, a person with $5,000 cash in a margin account can buy $8,000 worth of stocks by borrowing $3,000 in a margin account.
Margin accounts charge interests for the borrowed money, usually around 5-10% per year in Canada. Interests will only be charged when margin is used. Assume a person deposited $5,000 in a margin account. Trading less than $5,000 of stocks will not result to any interest since margin is not used.
When a person bought $8,000 total of stocks or other assets while only having $5,000 cash in a portfolio, margin of $3,000 will be triggered. In general, shares bought are used as a collateral when using margin.
Returns on Margin vs Without Margin
Assume a $15,000 cash is deposited on a margin account. On the margin example, $15,000 more is borrowed to afford buying $30,000 of stocks.
Let us say an investing platform charges 8% interest and another $15,000 is borrowed for six months. Interest expenses will be 8% x $15,000 x 6/12 months.
| Margin Used | Margin not Used | |
| Initial Investment | $ 15,000.00 | $ 15,000.00 |
| Margin used | $ 15,000.00 | $0 |
| Total Stock Position | $ 30,000.00 | $ 15,000.00 |
| Interest Expense (8%,6 mon.) | $ 600.00 | $0 |
Scenario 1: Stock Gained 25% in value
In this first scenario, a return of 25% on a stock will translate to a return of 46% when margin is used after interest costs and paying back the margin after 6 months.
| Margin used | Margin not used | |
| Total Stock Position | $ 30,000.00 | $ 15,000.00 |
| Stock Gains ($25%) | $ 7,500.00 | $ 3,750.00 |
| New Value | $ 37,500.00 | $ 18,750.00 |
| Interest Costs | $ 600.00 | $0 |
| Margin Paid Back | $ 15,000.00 | $0 |
| Net after Costs | $ 21,900.00 | $ 18,750.00 |
| Initial Investment | $ 15,000.00 | $ 15,000.00 |
| Profit | $ 6,900.00 | $ 3,750.00 |
| % Returns | 46% | 25% |
Scenario 2: Stock Gained 25% in value
In this scenario where the stock go down 25% after 6 months, returns would be -54% when margin is used compared to a return of -25% when margin is not used.
| Margin used | Margin not used | |
| Total Stock Position | $ 30,000.00 | $ 15,000.00 |
| Stock Loss ($25%) | -$ 7,500.00 | -$ 3,750.00 |
| New Value | $ 22,500.00 | $ 11,250.00 |
| Interest Costs | $ 600.00 | $0 |
| Margin Paid Back | $ 15,000.00 | $0 |
| Net after Costs | $ 6,900.00 | $ 11,250.00 |
| Initial Investment | $ 15,000.00 | $ 15,000.00 |
| Losses | -$ 8,100.00 | -$ 3,750.00 |
| % Returns | -54% | -25% |
Interest costs are typically tax deductible. This table does not take into account the taxes on stock gains/losses and interest costs.
An additional of $15,000 from margin is used on this example. When using a margin account, borrowing less than that amount is alright. For example, borrowing only $5,000 will bring to a total of $20,000 on a stock
Less margin means less leverage.
Interest Rates
Interest rates are typically 4-10% per year on margin accounts in Canada. Interest rates are triggered whenever margin is used. Margin is used when there is not enough cash to purchase a stock.
Let us say an order of 100 stocks at $200 each ($20,000 total) is entered on a margin account with only $15,000 cash. In this case, $5,000 will be borrowed from the Investment Dealer.
Interest rates will be charged until the borrowed money of $5,000 is paid off. This can be done by either selling $5,000 of stocks or by depositing money.
For instance, $5,000 is sold after 10 days. Assuming 8% margin rate, interest costs will be $10.96 ($5,000 x 8% x 10/365).
Risks of using Margin
Using margin on a margin account is optional. Interests will only be charged when margin is used and borrowed money to buy stocks.
Margin is used for leverage. Having $5,000 in equity and additional $5,000 is borrowed will result to having $10,000 on a stock. If this stock crashed 50%, the value of the stock will be $5,000 from the $10,000 original position. The remaining $5,000 will be used to pay the $5,000 borrowed money.
Overall, the $5,000 equity is lost from the 50% crash, and this is before the interest costs.
Like the big banks, Questrade Inc. is regulated by the IIROC (Investment Industry Regulatory Organization of Canada) and a CIPF member (Canadian Investor Protection Fund).
These can be confirmed by visiting the members list page on iiroc.ca and cipf.ca.
Amount on Margin
The maximum amount of margin depends on the investing platforms and how volatile a stock is. Let us say a person has $5,000 cash in a margin account.
Investing platforms usually allows more margin to be used when trading stable stocks like Walmart stock. In this case, up to $10,000 may be borrowed to buy a total of $15,000 in Walmart stock.
On the other hand, trading a volatile stock like Tesla will have less access to margin. In the same example of $5,000 capital, up to $3,000 more may be allowed to borrow for a total of $8,000 of Tesla stock maximum to buy.
Margins are typically 2:1 or 3:1, that is, for every $1000 cash a person can buy $2000 of stock on a 2:1 margin and $1000 is borrowed.
Every stock has its own margin requirements. A margin requirement of 30% means you can invest $3,000 and borrow $7,000 more on margin.
Margin Call
Margin call occurs when the value of a margin account falls below the minimum maintenance margin.
Calculating margin requirements may be complicated, but there is no need to calculate it. Maintenance excess is the amount of how much a stock can go down before a margin call is triggered. The amount of maintenance excess can be found on the platform.
When margin call happens, the broker will inform you to either deposit more money or to sell some stocks to lessen the exposure.
To avoid margin call, do not maximize the buying power and leave enough maintenance excess to afford potential downsides.
Margin call will not occur if margin is not used. Margin is not used if there is enough cash to purchase a stock.
Other ways to gain leverage
The most common alternative to buying stocks on margin to gain leverage is by trading put and call options.
Are margin accounts a good idea?
Margin accounts can enhance returns when a stock go in favor of your position. Margin enhances risks and rewards on a stock position. Generally, margin accounts are useful to trade stocks while waiting for a deposit to clear.
Instead of waiting 2-3 days for a deposit to clear, using margin to buy stocks immediately is an option, especially interest will only be charged on the 2-3 days that margin is used.
How are margin accounts taxed in Canada?
Margin accounts can be taxed in Canada as either a capital gain (50% taxable) or as a business income (fully taxable) when a trader does business activity such as frequent swing and day trading. Interest costs are usually tax deductible.
Is Margin interest tax deductible in Canada?
Margin interests are typically tax deductible in Canada. Interests are often considered as costs to an investments or costs on doing business activity like day trading,