A margin account is an account offered by brokerage firmsthat allows investors to borrow money to buy securities.
How aMargin Account Works
Brokers charge an interest rate on the borrowed money. Also, amaintenance margin is required meaning a minimum fixed dollar amount must be maintained in the account to be allowed to trade on margin.The minimum margin amount is calculated by subtracting the borrowed amount from the account'stotalequity which includes bothcash and the value of any securities.
How Much Can You Borrow?
An investor with amargin accountcan usually borrow up to 50% of the total purchase price of marginable investments. The percentage amount may vary between different investments and brokers. Each brokerage firm has the right to define which investments among stocks, bonds, or mutual funds can be purchased on margin.
Margin Calls
A margin call occurs when the investments in the account and the cash decrease in value and fall belowthe minimum maintenance margin amount. The investor mustdeposit additional fundsor sell a portion of the portfolio to fund the margin call. If the investor doesn't fund the account followinga margin call, the broker will sell some of the stocks in the account to make up the shortfall. The broker does not need the account holder'sapproval to sell any shares if the investor does not meet the margin call.
Example
An investor deposits $20,000 into a brokerage account and borrows an additional$10,000 from the broker. The investor has $30,000 to invest. However, the maintenance margin of $7,000 must be maintained between cash and the value of the stocks. As long as the account maintains a value of more than $7,000, the investor will not get a margin call.
However, it's important to rememberthat borrowing on margin could haveconsequences. A margin is leverage, which means that both your gains and losses are amplified. A margin is great when your investments are going up in value, but leverage can be adouble-edged sword and amplifylosses when the market is going down. A margin exposes investors to additional risks and isnot advisable for beginner investors, and margins can be a useful tool for experienced investors, though if you're new to investing, it might be more prudent toplay it safe.
FAQs
How does margin work? A margin account lets you leverage securities you already own as collateral for a loan to buy additional securities. Here's an example: Suppose you use $5,000 in cash and borrow $5,000 on margin to buy a total of $10,000 in stock.
What is a margin account and how does it work? ›
A “margin account” is a type of brokerage account in which the broker-dealer lends the investor cash, using the account as collateral, to purchase securities. Margin increases investors' purchasing power, but also exposes investors to the potential for larger losses. Learn More.
What is an example of how margin works? ›
Let's say that you deposit $10,000 in your margin account. Because you put up 50% of the purchase price, this means you have $20,000 worth of buying power. Then, if you buy $5,000 worth of stock, you still have $15,000 in buying power remaining.
What is buying on margin explain how it works? ›
Buying on margin involves getting a loan from your brokerage and using the money from the loan to invest in more securities than you can buy with your available cash. Through margin buying, investors can amplify their returns — but only if their investments outperform the cost of the loan itself.
How does the margin system work? ›
Because margin uses the value of your marginable securities as collateral, the amount you can borrow fluctuates day to day as the value of the marginable securities in your portfolio rises and falls. If the value of your portfolio rises, your buying power increases. If it falls, your buying power decreases.
Can I withdraw money from my margin account? ›
You can borrow cash from your margin accounts, but the amount of cash you can withdraw may be subject to your debit limit.
Is it worth getting a margin account? ›
While margin loans can be useful and convenient, they are by no means risk free. Margin borrowing comes with all the hazards that accompany any type of debt — including interest payments and reduced flexibility for future income. The primary dangers of trading on margin are leverage risk and margin call risk.
What is margin answer in one sentence? ›
A margin is the difference between two amounts, especially the difference in the number of votes or points between the winner and the loser in an election or other contest.
What is margin with an example? ›
In the business world, margin is the difference between the price at which a product is sold and the costs associated with making or selling the product (or cost of goods sold). Broadly speaking, a company's margin is its ratio of profit to revenue.
What is an example of a margin short? ›
For example, imagine that the investor deposits $2,000 into a margin account and would like to buy XYZ stock. Without margin, they are limited to buying $2,000 of XYZ. But by utilizing margin they may buy $4,000 of XYZ (assuming a 50% margin requirement).
Margin trading is when investors borrow money to buy stock. It's a risky trading strategy that requires you to deposit cash in a brokerage account as collateral for a loan, and pay interest on the borrowed funds.
How long can you hold a stock on margin? ›
You can keep your loan as long as you want, provided you fulfill your obligations. First, when you sell the stock in a margin account, the proceeds go to your broker against the repayment of the loan, until it is fully paid.
What happens if you lose margin money? ›
When the value of a margin account falls below the broker's required amount, the investor must deposit further cash or securities to satisfy the loan terms.
Can I use a margin account without borrowing money? ›
Cost of interest
While borrowing money in a margin account is by no means required, choosing to borrow funds is one way to be more flexible with your trading, as mentioned above.
How is margin paid back? ›
There is no monthly principal payment required (although interest will be due periodically) and no term in which you need to repay the loan, although you're allowed to repay part or all of your loan at any time. Potential tax advantages. Margin loan interest may be tax deductible depending on your situation.
How much money do you need to use margin? ›
To purchase a security on margin, FINRA (a government-authorized regulator of brokerage firms) requires that you have at least $2,000 or 100% of the security's purchase price (whichever value is less) deposited into your account.
How much money do you need to open a margin account? ›
You can use margin to finance securities purchases or to borrow against securities already held in your account. You must deposit at least $2,000 in cash or generally twice that in fully-paid eligible securities to open a margin account. It's important to note that trading on margin involves risk.
How risky are margin accounts? ›
In a margin account, your positions will usually be more sensitive to day-to-day market fluctuations, and if there is a really sharp decline, you could end up losing more than the total value of your account.
Do you pay taxes on a margin account? ›
Examples of activity in your account where income paid by you is taxable are: Interest paid by you on margin. This amount is reported on your Income Summary under "Paid by you." To determine whether a tax deduction applies in your situation, please consult with a tax or accounting advisor. Trading commissions.
What happens if you lose money on a margin account? ›
When the value of a margin account falls below the broker's required amount, the investor must deposit further cash or securities to satisfy the loan terms.
