When opening a brokerage account, you can choose a cash account, a margin account, or both. With a cash account, you invest your own money when buying stocks and other securities. A margin account lets you borrow money from your broker to buy securities, using the assets in your account as collateral. Trading on margin gives you more money to invest, which can boost your gains. But it also amplifies your losses, so it's essential to understand how it works.
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What is margin?
Margin is the cash, cash equivalents, and securities you deposit into your brokerage account as collateral to use money borrowed from your broker to buy additional securities. The total amount you have available to invest—including your own cash and the borrowed money—is called your buying power.
What is margin trading?
With a margin account, your broker lends you money against the value of the securities in your account—much like a bank lends you cash against the equity you have in your home. Margin trading, or buying on margin, is when you buy securities with borrowed money. Under Regulation T (aka "Reg T") of the Federal Reserve Board, you can borrow up to 50% of an investment's purchase price, but your broker might require a higher initial margin.
Components of margin trading
Three key rules govern margin trading: minimum margin, initial margin, and maintenance margin. While brokerage firms can establish their own "house" requirements, they can't be less restrictive than the rules set by the Federal Reserve Board, the securities exchanges, and self-regulatory organizations (SROs) such as the Financial Industry Regulatory Authority (FINRA).
1. Minimum margin (your deposit)
Minimum margin is the smallest amount of money you can deposit before trading on margin. The Financial Industry Regulatory Authority (FINRA) requires you to deposit at least $2,000 or 100% of the purchase price of the margin securities, whichever is less.
2. Initial margin (the amount you can borrow)
Initial margin is the percentage of the purchase price your own money must cover when buying securities on margin. Under Reg T, you can borrow up to 50% of the purchase price of margin securities. So, if you bought $10,000 worth of stock, you would pay $5,000, and your broker would lend you the other $5,000.
3. Maintenance margin (the amount you need after you trade)
Once you buy margin securities, your broker imposes a "maintenance" requirement on your margin account. The maintenance margin is the minimum amount of equity you must always maintain in your account. Per FINRA rules, the maintenance requirement must be at least 25% of the current market value of the margin securities.
How does margin trading work?
Margin trading doesn't happen automatically. Here are the basic steps to get started.
Apply for a margin account
Most brokerage firms offer margin accounts. If you don't have a margin account already, you can apply for one with your broker of choice. You'll fill out an online application and answer a few questions about your financial situation, investment knowledge, risk tolerance, and financial objectives. Public.com now offers margin accounts.
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Public App
Treasury bills
Buy treasury bills on Publicfor as little as $100 and track their yield over time directly in the app. Plus, you can manage your investments right alongside your stocks, ETFs, crypto, and alternative assets.
Fees:
5 basis points per month based on the average daily balance of your Treasury account.
Make the minimum margin deposit
Once your account is approved, you'll have to deposit a minimum of the lesser of $2,000 or 100% of the purchase price of the margin securities, though your broker may require more.
Find out which securities are marginable
Not all securities can be bought on margin or used as collateral for a margin account. While each broker can define which securities are marginable, the list generally includes most:
- Securities listed on the New York Stock Exchange (NYSE).
- NASDAQ/AMEX securities.
- Mutual funds you've owned for at least 30 days.
- Investment-grade corporate, municipal, and government bonds.
Consider the interest
Like all loans, margin loans involve interest. Margin interest rates are usually lower than those on unsecured personal loans and credit cards. The interest charges accrue each month to your account, and you can repay the loan at your convenience with no fixed repayment schedule. Sometimes, you can deduct the interest if you use the margin to buy taxable investments and itemize your deductions at tax time (consult a tax professional for help). For these reasons, margin loans can be a flexible and affordable way to borrow.
Still, the interest you pay lowers your returns, increasing the amount your investment must earn to break even. Interest rates vary significantly by broker, so consider this expense when comparing your margin account options.
Understand margin calls
You'll receive a margin call from your broker if your account falls below its maintenance margin requirement. A margin call is a demand from your broker to increase the equity in your account—either by depositing cash or margin-eligible securities into the account or selling securities in the account. If you don't satisfy the margin-call requirements, your broker can sell (liquidate) your positions to bring the equity in your account up to or above the required level.
Importantly, your broker can do this without consulting you first. For this reason, it's essential to understand your broker's rules—and never ignore a margin call. Read your margin agreement and know how much your portfolio can decline in value before prompting a margin call.
Example of margin trading
Here's an example illustrating how margin can work in your favor or against you. We don't include commissions, fees, or margin interest for simplicity's sake.
Say you have $10,000 cash in your brokerage account. You want to buy a stock that costs $100 per share, so you use your $10,000 to purchase 100 shares. A year later, the stock price increases to $120, and you sell your position for $12,000—earning a $2,000 profit.
Now, assume you start with the same $10,000, but have margin privileges. In that case, you could buy 100 shares with your $10,000 plus another 100 shares on margin. The following year, the stock price increases to the same $120, and you sell your 200 shares for $24,000. After repaying the $10,000 you borrowed, you end up with a $4,000 profit—twice the amount you earned without margin.
Of course, margin trading also magnifies your losses. Say the stock price falls to $90 the next year, and you close out your position for $18,000. Once you repay the $10,000, you have $8,000 left of your initial investment—meaning you lose $2,000. Without margin, you would have lost just $1,000.
The pros and cons of margin trading
Pros:
- Magnifies your profits
- Boosts purchasing power (leverage)
- Repayment flexibility
- Lower interest rates than other loans
- More investing options (short selling, options)
Cons:
- Magnifies your losses
- Interest charges
- Margin calls
- Forced liquidation (risk of not meeting margin call)
Advantages of margin trading
A key benefit of margin is that it boosts your buying power, resulting in larger profits on winning trades. Margin loans also offer lower interest rates and more flexibility than other loans because there's no fixed repayment schedule. A margin account also enables you to trade certain options strategies and participate in short selling—when you attempt to profit from securities that decline in value.
Disadvantages of margin trading
Trading on margin can boost your profits, but the trade-off is that it also amplifies your losses. Margin also comes at a cost: You'll owe interest on the money you borrow, no matter how your investment performs. Margin calls are another drawback. If you're unable to meet a margin call, your broker can liquidate your positions and revoke your margin privileges.
What are the risks involved in margin trading?
A primary hazard of margin trading is leverage risk: Margin can amplify your losses as dramatically as it can increase your wins. Margin-call risk is another danger. As noted, if the equity in your account falls below your broker's maintenance margin requirement, you'll get a margin call. If you don't respond promptly, your broker can sell securities in your account to increase the equity (aka "forced liquidation")—and they don't have to notify you first.
What strategies are used to maximize returns on margin?
Several basic tips and strategies can help you maximize your returns when trading on margin:
- Only trade on margin once you've gained experience and understand how the market works.
- Leave a cash cushion in your account to limit the chance of a margin call.
- Consider capping your leverage to limit your potential losses.
- Use stop-loss orders to exit losing positions automatically at a predetermined price.
- Remember that margin loans involve interest and shop around if your broker's rate seems too high.
How to decide if margin trading is right for you
Margin trading is best suited for experienced investors who are comfortable with the risks and understand how to use margin safely. Newer investors are generally better off using a cash account while learning about the financial markets.
You also need to be the kind of investor who enjoys being actively involved in the market; margin trading is not a “buy it and forget it” activity.
Tougher requirements for active traders
If you’re a really active investor, you’ll encounter much higher minimum equity requirements for your margin account. Most investors hold their investments for months or years, expecting to buy low and sell high. However, some active investors and traders prefer getting in and out of the market quickly, attempting to profit from small, frequent price fluctuations. Because short-term trading is generally riskier than buy-and-hold strategies (for both the trader and the brokerage firm), the margin requirements are higher for anyone designated as a "pattern day trader."
Your broker can designate you as a pattern day trader if you execute four or more "day trades" within five business days. A day trade is when you buy and sell (or sell and buy, in the case of short selling) the same security on the same day in a margin account. FINRA rules require brokers to impose special margin requirements for pattern day traders, with a minimum equity requirement of $25,000 instead of the usual $2,000 for most investors.
TIME Stamp: Experienced investors willing to invest the time can profit from margin trading
If your stocks do well, you can make more money trading on margin than with a cash account. The reverse is also true: You can lose more money, much faster, if your margin investments tank.
Frequently asked questions (FAQs)
What is a margin call?
A margin call is a demand from your broker to meet the account's maintenance margin requirements. You'll receive a margin call if you trade for more than your account's buying power, the value of your margin account decreases, or your broker raises its house maintenance margin requirements.
To meet a margin call, you can deposit cash or margin-eligible securities into the account or sell securities to increase your account equity. If you don't meet a margin call, your broker has the right to sell the securities you bought on margin without notifying you—potentially at a substantial loss.
What are the requirements for margin trading?
There are three requirements for margin trading. The first, minimum margin, is the minimum amount you must deposit before trading on margin. FINRA sets the minimum at $2,000 or 100% of the purchase price of the margin securities, whichever is less.
The second requirement, initial margin, is the percentage of the purchase price covered with your own cash. Reg T lets you borrow up to 50% of the purchase price.
The third requirement, maintenance margin, is the percentage of your own funds that you have to keep in your account when you own margin securities. FINRA sets the minimum at 25% of the securities' current market value.
What is 5% margin trading?
Some instruments, including Forex, give traders access to substantial leverage through margin. When the leverage is 20:1, or 5% margin, you can trade $20 for every $1 of available margin in your account. So, for example, if you have $100 in your account, you could buy $2,000 worth of an asset.
Should beginners trade on margin?
Margin increases your buying power, but it also magnifies your losses. For this reason, it's generally advisable to use margin only once you gain investment experience and proficiency, and are no longer a beginner.
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