how a margin account works
if an investor purchases securities with margin funds and those securities appreciate in value beyond the interest rate charged on the funds the investor will earn a better total return than if they had only purchased securities with their own cash this is the advantage of using margin funds on the downside the brokerage firm charges interest on the margin funds for as long as the loan is outstanding increasing the investor s cost of buying the securities if the securities decline in value the investor will be underwater and will have to pay interest to the broker on top of that if a margin account s equity drops below the maintenance margin level the brokerage firm will make a margin call to the investor within a specified number of days typically within three days although in some situations it may be less the investor must deposit more cash or sell some stock to offset all or a portion of the difference between the security s price and the maintenance margin a brokerage firm has the right to ask a customer to increase the amount of capital they have in a margin account sell the investor s securities if the broker feels their own funds are at risk or sue the investor if they do not fulfill a margin call or if they are carrying a negative balance in their account the investor has the potential to lose more money than the funds deposited in the account for these reasons a margin account is only suitable for a sophisticated investor with a thorough understanding of the additional investment risks and requirements of trading with margin a margin account may not be used for buying stocks on margin in an individual retirement account a trust or other fiduciary accounts in addition a margin account cannot be used with stock trading accounts of less than 2 000 1margin on other financial productsfinancial products other than stocks can be purchased on margin futures traders also frequently use margin for example with other financial products the initial margin and maintenance margin will vary exchanges or other regulatory bodies set the minimum margin requirements although certain brokers may increase these margin requirements that means the margin may vary by broker the initial margin required for futures is typically much lower than for stocks while stock investors must put up 50 of the value of a trade futures traders may only be required to put up between 3 to 12 21margin accounts are required for most options trading strategies as well example of a margin accountassume an investor with 2 500 in a margin account wants to buy a stock for 5 per share the customer could use additional margin funds of up to 2 500 supplied by the broker to purchase 5 000 worth of stock or 1 000 shares if the stock appreciates to 10 per share the investor can sell the shares for 10 000 if they do so after repaying the broker s 2 500 and not counting the original 2 500 invested the trader profits 5 000 had they not borrowed funds they would have only made 2 500 when their stock doubled by taking double the position the potential profit was doubled had the stock dropped to 2 50 though all the customer s money would be gone since 1 000 shares 2 50 is 2 500 the broker would notify the client that the position is being closed unless the customer puts more capital in the account the customer has lost their funds and can no longer maintain the position this is a margin call the above scenarios assume there are no fees however interest is paid on the borrowed funds if the trade took one year and the interest rate is 10 the client would have paid 10 2 500 or 250 in interest their actual profit is 5 000 less 250 and commissions even if the client lost money on the trade their loss is increased by the 250 plus commissions can you lose all of your money on margin you can lose more than all of your money on margin for example if you made a trade by borrowing 50 on margin half of the trade is funded with borrowed capital now say the stock you invested in lost 50 you would have a loss of 100 in your portfolio add to this any commissions and fees and you ve lost more than the money you put in you ve lost money you may not have can stocks go to zero yes any stock can go to zero while it is highly unlikely that a stock will go to zero it is possible particularly if a company goes bankrupt if you owned the stock and it fell to zero you would lose the entire amount you invested in the stock 