how the process works
buying on margin is borrowing money from a broker in order to purchase stock you can think of it as a loan from your brokerage margin trading allows you to buy more stock than you d be able to normally to trade on margin you need a margin account this is different from a regular cash account in which you trade using the money in the account with a margin account you deposit cash which serves as the collateral for a loan to purchase securities you can use this to borrow up to 50 of the purchase price of an investment so if you deposit 5 000 you could buy up to 10 000 in securities your broker will charge interest on this loan you re using which you ll need to repay if you sell your securities the proceeds will pay off your loan first and you can keep what s left the financial industry regulatory authority finra and the securities and exchange commission sec regulate margin trading with strict rules as to how much you must deposit how much you can borrow and how much you must keep in your account 2components of margin tradingby law your broker is required to obtain your consent to open a margin account the margin account may be part of your standard account opening agreement or may be a completely separate agreement an initial investment of at least 2 000 is required for a margin account though some brokerages require more this deposit is known as the minimum margin 2once the account is opened and operational you can borrow up to 50 of the purchase price of a stock this portion of the purchase price that you deposit is known as the initial margin it s essential to know that you don t have to margin all the way up to 50 you can borrow less say 10 or 25 be aware that some brokerages require you to deposit more than 50 of the purchase price 2you can keep your loan as long as you want provided you fulfill your obligations such as paying interest on time on the borrowed funds 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 there is also a restriction called the maintenance margin which is the minimum account balance you must maintain before your broker will force you to deposit more funds or sell stock to pay down your loan when this happens it s known as a margin call a margin call is effectively a demand from your brokerage for you to add money to your account or close out positions to bring your account back to the required level if you do not meet the margin call your brokerage firm can close out any open positions in order to bring the account back up to the minimum value your brokerage firm can do this without your approval and can choose which position s to liquidate in addition your brokerage firm can charge you a commission for the transaction s you are responsible for any losses sustained during this process and your brokerage firm may liquidate enough shares or contracts to exceed the initial margin requirement special considerationsbecause using margin is a form of borrowing money it comes with costs and marginable securities in the account are collateral the primary cost is the interest you have to pay on your loan the interest charges are applied to your account unless you decide to make payments over time your debt level increases as interest charges accrue against you as debt increases the interest charges increase and so on therefore buying on margin is mainly used for short term investments the longer you hold an investment the greater the return that is needed to break even if you hold an investment on margin for a long period of time the odds that you will make a profit are stacked against you not all stocks etfs or other investment securities qualify to be bought on margin also not all exchanges or brokers allow margin on the investment products they handle cryptocurrency is an example of an investment where margin trading might be limited the federal reserve board regulates which stocks are marginable 3 as a rule of thumb brokers will not allow customers to purchase penny stocks or initial public offerings ipos on margin because of the day to day risks involved with these types of stocks individual brokerages can also decide not to margin certain stocks so check with them to see what restrictions exist on your margin account significant margin calls may have a domino effect on other investors should a single major investor face a significant margin call their forced liquidation may decrease the value of the securities held as collateral by other margin traders putting these investors at risk of a margin call of their own advantages and disadvantages of margin tradingmay result in greater gains due to leverageincreases purchasing poweroften has more flexibility than other types of loansmay be self fulfilling opportunity cycle where increases in collateral value further increase leverage opportunitiesmay result in greater losses due to leverageincurs account fees and interest chargesmay result in margin calls which require additional equity investmentsmay result in forced liquidations which result in the sale of securities often at a loss the primary reason investors margin trade is to capitalize on leverage margin trading centers increasing purchasing power by increasing the capital available to purchase securities instead of buying securities with money you own investors can buy more securities using their capital as collateral for loans greater than their capital on hand for this reason margin trading can amplify profits again with more securities in hand increases in value have greater consequential outcomes because you re more heavily invested using debt on the same note if the value of the securities posted as collateral also increase you may be able to further utilize leverage as your collateral basis has increased margin trading is also usually more flexible than other types of loans there may not be a fixed repayment schedule and your broker s maintenance margin requirements may be simple or automated for most margin accounts the loan is open until the securities are sold in which final payments are often due to the borrower if investors primarily enter into margin trading to amplify gains they must be aware that margin trading also amplifies losses should the value of securities bought on margin rapidly decline in value an investor may owe not only their initial equity investment but also additional capital to lenders margin trading also comes at a cost brokers often charge interest expense and these fees are assessed regardless of how well or poorly your margin account is performing because there are margin and equity requirements investors may face a margin call this is a requirement from the broker to deposit additional funds into their margin account due to the decrease in the equity value of securities being held investors must be mindful of needing this additional capital on hand to satisfy the margin call 