Margin Trading: What Is Buying On Margin?
  1. Margin Trading: Introduction
  2. Margin Trading: What Is Buying On Margin?
  3. Margin Trading: The Dreaded Margin Call
  4. Margin Trading: The Advantages
  5. Margin Trading: The Risks
  6. Margin Trading: Conclusion

Margin Trading: What Is Buying On Margin?

The Basics
Buying on margin is borrowing money from a broker 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. By law, your broker is required to obtain your signature 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. Once 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.

You can keep your loan as long as you want, provided you fulfill your obligations. First, 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. Second, 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. We'll talk about this in detail in the next section.

Borrowing money isn't without its costs. Regrettably, marginable securities in the account are collateral. You'll also have to pay the interest 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 qualify to be bought on margin. The Federal Reserve Board regulates which stocks are marginable. As a rule of thumb, brokers will not allow customers to purchase penny stocks, over-the-counter Bulletin Board (OTCBB) securities 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.

A Buying Power Example
Let's say that you deposit $10,000 in your margin account. Because you put up 50% of the purchase price, this means you have $20,000 worth of buying power. Then, if you buy $5,000 worth of stock, you still have $15,000 in buying power remaining. You have enough cash to cover this transaction and haven't tapped into your margin. You start borrowing the money only when you buy securities worth more than $10,000.

This brings us to an important point: the buying power of a margin account changes daily depending on the price movement of the marginable securities in the account. Later in the tutorial, we'll go over what happens when securities rise or fall.

Margin Trading: The Dreaded Margin Call

  1. Margin Trading: Introduction
  2. Margin Trading: What Is Buying On Margin?
  3. Margin Trading: The Dreaded Margin Call
  4. Margin Trading: The Advantages
  5. Margin Trading: The Risks
  6. Margin Trading: Conclusion
RELATED TERMS
  1. Minimum Margin

    The initial amount required to be deposited in a margin account ...
  2. Margin Call

    A broker's demand on an investor using margin to deposit additional ...
  3. Margin Loan Availability

    1. The dollar amount in an existing margin account that is currently ...
  4. Initial Margin

    The percentage of the purchase price of securities (that can ...
  5. Margin Account

    A brokerage account in which the broker lends the customer cash ...
  6. Margin

    1. Borrowed money that is used to purchase securities. This practice ...
RELATED FAQS
  1. What happens if I cannot pay a margin call?

    Minimum margin is the amount of funds that must be deposited with a broker by a margin account customer. With a margin account, ... Read Answer >>
  2. Why is purchasing stocks on margin considered more risky than traditional investing?

    Learn why purchasing stocks on margin is riskier than traditional investing, although it can be more profitable when it is ... Read Answer >>
  3. How exactly does buying on margin work and why is it controversial?

    Learn how purchasing stock on margin works, and understand the risk associated with margin accounts that make the strategy ... Read Answer >>
  4. Do you have to sell your stocks when you get a margin call?

    Understand the implications of a margin call and what an investor's options are when the stock he purchased on margin falls ... Read Answer >>
  5. What does it mean when I get a maintenance margin call?

    Understand how maintenance margin calls work, and learn about how margin requirements are different for trading stock versus ... Read Answer >>
  6. What does it mean when the shares in my account have been liquidated?

    An account liquidation occurs when the holdings of an account are sold off by the firm in which the account was created. ... Read Answer >>
Hot Definitions
  1. Goldilocks Economy

    An economy that is not so hot that it causes inflation, and not so cold that it causes a recession. This term is used to ...
  2. White Squire

    Very similar to a "white knight", but instead of purchasing a majority interest, the squire purchases a lesser interest in ...
  3. MACD Technical Indicator

    Moving Average Convergence Divergence (or MACD) is a trend-following momentum indicator that shows the relationship between ...
  4. Over-The-Counter - OTC

    Over-The-Counter (or OTC) is a security traded in some context other than on a formal exchange such as the NYSE, TSX, AMEX, ...
  5. Quarter - Q1, Q2, Q3, Q4

    A three-month period on a financial calendar that acts as a basis for the reporting of earnings and the paying of dividends.
  6. Weighted Average Cost Of Capital - WACC

    Weighted average cost of capital (WACC) is a calculation of a firm's cost of capital in which each category of capital is ...
Trading Center