What is a 'Margin Account'
A margin account is a brokerage account in which the broker lends the customer cash to purchase securities. The loan in the account is collateralized by the securities and cash. Because the customer is investing with a broker's money rather than his own, the customer is using leverage to magnify both gains and losses.
BREAKING DOWN 'Margin Account'
A margin account lets an investor borrow money from a broker to purchase securities up to double the account’s cash balance. For example, an investor with $2,500 in a margin account buys Company A’s stock for $5 per share. With the broker's $2,500 loan, the investor purchases $5,000 of Company A’s stock and receives 1,000 shares. The stock appreciates $10 per share, and the investor makes $10,000.
Margin Account Pros and Cons
With a 50% margin, an investor owns twice as much stock; depending on the stock’s performance, he realizes twice the gain or loss when compared to paying the entire purchase in cash. The brokerage firm charges interest on the balance of the securities’ purchase price for as long as the loan is outstanding, increasing the investor’s cost for buying the securities.
If a margin account’s equity drops below a set amount of the maintenance margin or total purchase amount, the brokerage firm makes a margin call to the investor. Within three days, the investor deposits more cash or sells 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 increase the minimum amount required in a margin account, sell the investor’s securities without notice or sue the investor if he does not fulfill a margin call. Therefore, the investor has the potential to lose more money than the funds deposited in his account. For these reasons, a margin account is more suitable for a sophisticated investor understanding the additional investment risks and requirements.
Federal Regulations on Margin Accounts
A margin account may not 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.