A margin account is a brokerage account that allows the customer to use leverage to purchase securities. This means the account holder can take a loan from the broker to make investments. Margin rules are federally regulated, but margin requirements and interest may vary among brokers and dealers.
Most brokers offer the ability to set up a margin account and can give you a lot of buying power without much cash investment on the trader’s part. To understand how margin accounts can be helpful, consider an investor who bought a share of stock for 50 US Dollars ($); after that, the stock’s market price went up to $75. If he paid cash for it, the return on his investment would be 50%, which is a very respectable rate of return. However, if he paid $25 in cash and $25 in funds borrowed on margin, his return is 100%. He still has to pay back the money he borrowed, but by spreading his margin borrowing over several purchases, he will increase his profits as long as his stock price goes up.
Brokerages offer A margin account that allows investors to borrow money to buy securities. An investor might put down 50% of the purchase price and borrow the rest from the broker. The broker charges the investor interest for the right to borrow money and uses the securities as collateral. However, in volatile markets, a broker may calculate the account value at the close and then continue to calculate calls on subsequent days in real-time. A margin loan can be valuable in the right circumstances, but be aware that it can magnify profits and losses.
Once your account’s equity drops down and you get under the maintenance margin threshold of your broker, they have the right to issue a “Margin Call.” A margin call says that your broker can sell your positions without your consent to get their investment back. Alternatively, they may require you to deposit additional capital into your account to get you back above the maintenance margin threshold.
Buying on margin is mainly used for short-term investments because of the interest charges. Margin works well when investments are going up in value but can be crippling if the value goes down. That’s why margin accounts are better suited for sophisticated investors knowledgeable in additional investment risks and demands.
The Federal Reserve limits the amount that may be borrowed on margin to 50% of the value of the purchase. A margin account is necessary when selling stocks short and is usually used by people who want to leverage their investment rather than people who can’t afford the full purchase price of the securities.
Besides that, a margin account cannot be used for buying stocks on margin for an individual retirement account (IRA), Uniform Gift to Minor account (UGMA), a trust, or other fiduciary account; these accounts require cash deposits. In addition, a margin account cannot be used when purchasing less than $2,000 in stock, buying stock in an initial public offering (IPO), buying stock trading at less than $5 per share, or for stocks trading anywhere other than the New York Stock Exchange (NYSE) or the NASDAQ National Market.
Although using a highly leveraged margin may increase the potential for gains, traders should carefully consider the risks and costs before entering their trades.