Robinhood app is one of the most popular investment apps for individual investors. It offers commission-free trading of stocks, ETFs, options and cryptocurrencies. One of the key features of Robinhood is the ability to invest on margin. Margin investing allows investors to borrow money from brokerages to buy more stocks. While this can amplify gains, it also increases risks. In this article, we will take a deep look at how margin works on Robinhood app, and the pros and cons of investing on margin.
How margin investing works on Robinhood app
Robinhood offers margin investing accounts to users who meet certain eligibility criteria. Currently, Robinhood Gold users with over $2,000 account balance can apply for a margin account. Once approved, investors can borrow up to 50% of their account balance, at an annual interest rate starting from 5%. For example, if you have $10,000 in stocks, you can borrow up to $5,000 on margin to buy more stocks. Robinhood charges interest only on the borrowed amount, not the full account balance. This allows investors to leverage their existing capital to generate higher potential returns. However, it also amplifies losses if share prices decline.
The pros of investing on margin on Robinhood
There are some advantages to using margin on the Robinhood app:
1. Increased buying power – With limited capital, margin allows you to own more shares and diversify your portfolio.
2. Potentially higher returns – If your margin trades generate gains exceeding the interest costs, using leverage boosts overall returns.
3. Access to short selling – Margin accounts on Robinhood allow shorting stocks to profit from price declines.
4. Avoid taxable events – Rather than selling stocks, you can borrow on margin to access funds when needed.
5. More day trades – Margin accounts have higher day trading limits compared to cash accounts.
The risks of margin investing on Robinhood
While margin can turbocharge your investment returns, it also dramatically increases downside risks:
1. Margin calls – If share prices fall significantly, brokerages can force the sale of securities in your account to repay margin loans.
2. Higher interest costs – Margin interest charges increase with loan amounts and duration.
3. Amplified losses – Not only do you lose your equity, you still have to repay the margin loans.
4. Forced liquidation – Brokerages can sell your securities without consent to cover margin requirements.
5. Potential account closures – Failing to meet margin requirements can lead to account suspension or closure.
Tips for using margin safely on Robinhood
Here are some tips to use margin judiciously and reduce risks:
1. Limit margin usage to 20-30% of your account value. Don’t over-leverage.
2. Use margin only for short term opportunities. Don’t borrow for the long term.
3. Invest margin in high quality stocks only. Avoid speculative investments.
4. Maintain a buffer to account for market corrections and avoid margin calls.
5. Develop a plan to reduce leverage if market conditions deteriorate.
6. Closely track your margin balance. Be prepared to deposit more funds if needed.
In summary, Robinhood allows investors to amplify their returns by investing on margin. While leverage can boost gains, margin also dramatically increases downside risks. Investors should use margin judiciously only after understanding the risks, and implement proper risk management.