Do you understand margin trading? A must-read guide for retail investors on avoiding pitfalls in two-way trading

There is more than one way to make money in the stock market. Many people only know how to “buy and hold,” but they are unaware of two other strategies: margin financing to amplify gains and short selling for inverse profits. While these two methods seem simple, they hide multiple risks such as margin calls, interest costs, and being forced to liquidate positions. Today, we will delve into the operational logic of these tools, their cost structures, and how to avoid traps that could wipe out your capital.

What is Margin Financing? Using Others’ Money to Boost Your Returns

Simply put, margin financing means you put in a portion of the money, and the brokerage provides the rest to buy stocks. The stock then becomes the collateral for the broker.

Why do this? Because it allows you to participate in full stock price movements with less of your own capital. For example, if you are bullish on Apple stock but only have $40, through margin financing you can invest $100 in Apple shares, borrowing the remaining $60 from the broker.

Here’s a real example to illustrate the power:

Suppose Apple’s stock price rises from $100 to $150, a 50% increase. But if you bought on margin, your initial $40 investment could turn into about $90 profit ($150 - $60 borrowed - interest), resulting in a return of up to 125%. The gains are magnified, but so are the losses, which is why margin should be used cautiously.

The True Cost of Margin Financing: Annual Interest Rate 4.5%-6.65%, Calculated Daily

Since margin financing is borrowing, interest must be paid. This interest is calculated daily. In Taiwan’s securities market, annual interest rates typically range from 4.5% to 6.65%.

The calculation formula is straightforward: Interest = Margin Amount × Annual Rate × Borrowed Days ÷ 365

For example, if you borrow NT$1,200,000 to buy a stock priced at NT$2,000, with an annual interest rate of 6.65%, holding for 20 days, the interest cost would be about NT$4,372. This is why margin trading is usually not held long-term—interest gradually erodes your profits.

The Deadly Risks of Margin Financing 1: Margin Calls

This is the most frightening risk. When stock prices fall, the broker sets a “maintenance margin ratio.” If the stock drops below this level, they will notify you to add more collateral. If you fail to do so within the deadline, the broker has the right to forcibly sell your stocks, known as a “margin call liquidation.”

Real case: Xiao Xiong bought TSMC shares at NT$500 with NT$20,000 of his own money and NT$30,000 borrowed. The initial maintenance margin was 166.7%.

Later, due to interest rate hikes, geopolitical issues, and pandemic black swan events, TSMC’s stock fell to NT$380, and the maintenance margin dropped to 126.7%. The broker saw that the NT$30,000 collateral might not be recoverable and immediately notified Xiao Xiong: “You must add collateral within 2 days, or I will sell your stocks.”

Ways to meet margin calls:

• Add enough funds to bring the margin ratio above 130%, temporarily avoiding forced sale, but if the stock continues to fall, you must keep topping up.
• Replenish to above 166.7%, returning to the safest level.

This explains why during major market swings, headlines often mention “margin calls” or “imminent forced liquidations.”

The Deadly Risks of Margin Financing 2: Long-term Holding Can Lead to Interest Losses

If you buy stocks and they remain stagnant—neither rising nor falling—then:

• Buying outright: no profit, no loss
• Using margin: losing interest costs

Especially for high-dividend stocks with only 4-5% yield, the margin interest can eat into your dividends, making it less worthwhile. Therefore, margin is suitable for short-term trading, not for “buy-and-hold” investors.

How to Avoid Margin Risks?

1. Choose the right stocks carefully

Margin trading is suitable for stocks with upcoming major positive news but not yet rising. Always select large-cap, highly liquid stocks to avoid being forced to sell during black swan events or being unable to cut losses.

2. Set strict stop-loss and take-profit points

Since margin amplifies both gains and losses, stop-loss and take-profit are especially important. Use technical analysis: cut losses immediately if support levels break, and take profits when approaching resistance zones.

3. Keep cash on hand

Because a low maintenance margin can lead to margin calls at any time, always reserve enough cash for emergencies.

4. Use staggered positions to reduce risk

Avoid going all-in at once; instead, build positions gradually. Buy at relatively low points first, and if the stock continues to fall but you remain confident, add more. This way, even if the stock eventually rises, you can participate in gains. Diversify across industries to increase overall expected returns—if one sector consolidates while another rises, your overall portfolio benefits.

Short Selling: Borrow Stocks from the Broker for Inverse Profits

If margin financing is bullish (long), short selling is bearish (short). You borrow stocks from the broker to sell, then buy them back after the price drops, returning the shares to the broker. The difference between the selling and buying prices is your profit.

Short selling requires collateral worth about 90% of the stock’s market value in cash. It sounds simple, but the risks are significant:

Risk 1: Forced buy-back

Taiwan’s short selling has expiration dates. Before dividends, shareholder meetings, or during certain periods, brokers may force you to buy back the shares. Also, interest on the short position must be paid, which can eat into profits.

Risk 2: Margin maintenance issues leading to forced liquidation

If the stock price rises instead of falling, you will incur losses. To protect themselves, brokers set a maintenance margin. If the stock keeps rising and your margin ratio falls below the standard, you face forced buy-back risk, and your remaining funds will be used to cover the position.

Risk 3: Being “Gao Kong” (being squeezed)

Some investors target stocks with high short interest to push the price up, forcing short sellers to buy back at higher prices, profiting from the squeeze. Before shorting, always check the current short interest to avoid being caught in a short squeeze.

Margin Financing vs Short Selling: Pros and Cons of Two-Way Trading

Final Advice: Risk Management Is the Key to Consistent Success

Both margin financing and short selling are powerful tools, but tools themselves are neither good nor bad—it’s how you use them. True investing experts not only understand fundamentals and technical analysis but also strictly control risks.

Key points:

• Research your targets thoroughly; avoid following the crowd blindly
• Enforce strict stop-loss and take-profit rules; discipline is essential for longevity
• Monitor maintenance margins and short interest regularly; don’t let brokers or market manipulators dictate your fate
• Always keep cash reserves and mental preparedness; markets always have black swans

Using margin and short selling correctly can amplify gains, but misusing them accelerates losses. Understanding the market, leveraging tools wisely, and managing risks are the true paths to making money in the stock market.