Margin can be used to manage risk either through employing hedging strategies or just generally increasing the overall diversification of your portfolio.
One way to hedge, or make an investment that reduces the risk of another investment, is through short selling. When you enter into a short trade to hedge, you're using your short position to offset or protect a long position.
By holding both a short and long position in the same security, you're potentially managing the risk associated with the security by attempting to ensure that a move in either direction won't make or break your portfolio.
A margin account is required for short selling.
Another way to use margin as a risk management tool is to apply the funds you borrow toward the task of diversifying your portfolio. By diversifying your holdings, you're attempting to manage your portfolio according to your risk tolerance. In theory, more diversified portfolios offer lower exposure to risk. Keep in mind that margin should supplement your overall risk strategy when used this way.
As a risk management tool, margin can provide additional funds to help you purchase multiple securities with low correlations to one another thereby attempting to ensure that your portfolio isn't entirely dependent upon one sector, industry or stock.
Keep in mind that while diversification may help spread risk it does not assure a profit, or protect against loss, in a down market.
This article is for information purposes only and use of strategies does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security or account type before making an investment decision. Scottrade's margin agreement is available at scottrade.com, or through a Scottrade branch office, and contains the Margin Disclosure Statement and information on our lending policies, interest charges, and the risks associated with margin accounts.