Loading the player...

What is 'Buying On Margin'

Buying on margin is the purchase of an asset by paying the margin and borrowing the balance from a bank or broker. Buying on margin refers to the initial or down payment made to the broker for the asset being purchased; the collateral for the borrowed funds is the marginable securities in the investor's account. Before buying on margin, an investor needs to open a margin account with the broker.

BREAKING DOWN 'Buying On Margin'

In the United States, the Federal Reserve Board regulates the amount of margin that an investor must pay for a security. As of 2016, the Federal Reserve Board requires an investor to fund at least 50% of a security's purchase price with cash. The investor may borrow the remaining 50% from a broker or a dealer.

How to Buy on Margin

Based on creditworthiness and other factors, the broker sets the minimum or initial margin and the maintenance margin that must exist in the account before the investor can begin buying on margin. Maintenance margin refers to the minimum amount of money that must exist in the account before the broker forces the investor to deposit more money.

Suppose an investor deposits $10,000 and the maintenance margin is 50%, or $5,000. As soon as the investor's equity dips even a dollar below $5,000, the investor may receive a margin call. When this happens, the broker calls the investor and demands that the investor bring his balance back to the required maintenance margin level. The investor can do this by depositing additional cash into his brokerage account or by selling securities that he purchased with borrowed money.

Buying on Margin Benefits and Risks

Buying on margin offers investors some definite benefits, but the practice is also fraught with risk. Using this kind of leverage to purchase securities with someone else's money amplifies gains when the value of those securities increases, but it magnifies losses when the securities decline in value.

Consider an investor who purchases 100 shares of Company XYZ stock at $50 per share. He funds half of the purchase price with his own money and the other half he buys on margin, making his initial cash outlay $2,500. After a year, the share price doubles to $100. The investor sells his shares for $10,000 and pays back his broker the $2,500 he borrowed for the initial purchase. Ultimately, he triples his money, making $7,500 on a $2,500 investment. Had he purchased the same number of shares outright using his own money, he would only have doubled his money, from $5,000 to $10,000.

Now consider that instead of doubling after a year, the share price falls by half, to $25. The investor sells at a loss and receives $2,500. Since this equals the amount he owes his broker, he loses 100% of his investment on the deal. Had he not used margin to make his initial investment, he still would have lost money, but he would only have lost 50% of his investment.

RELATED TERMS
  1. Margin Call

    A broker's demand on an investor using margin to deposit additional ...
  2. Minimum Margin

    Minimum margin is the initial amount required to be deposited ...
  3. Margin

    1. Borrowed money that is used to purchase securities. This practice ...
  4. Credit Balance

    In a margin account, A credit balance is the sum of proceeds ...
  5. Broker's Call

    A broker's call is the interest rate charged by banks on loans ...
  6. Exhaust Price

    A discount price at which a broker must liquidate a client's ...
Related Articles
  1. Investing

    Leveraged Investment Showdown

    Margin loans, futures and ETF options can all mean better returns, but which one should you pick?
  2. Investing

    Picking your first broker

    If you're a rookie investor, choosing a broker may be your first big investment decision. Learn more on whether you should you go with a full-service broker or a discount broker.
  3. Investing

    Spreading The Word About Portfolio Margin

    An underused opportunity provided in an SEC rule can enhance returns and lower risk for spread traders.
  4. Trading

    Does NYSE Margin Debt Indicate a Continuous Rally in the U.S. Stock Market?

    Discover a tight correlation between NYSE total margin debt and the S&P 500 and why investors should be patient before overreacting to a correlation.
  5. Investing

    A Look At Corporate Profit Margins

    Take a deeper look at a company's profitability with the help of profit margin ratios.
RELATED FAQS
  1. 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 >>
  2. What are my options when I get a margin call?

    Understand what a margin call means and the two primary options for meeting a margin call, such as depositing additional ... Read Answer >>
  3. How is buying on margin regulated by the Securities and Exchange Commission (SEC)?

    Learn how FINRA and the Federal Reserve regulate margin account trading, and understand how pattern day trading can impact ... Read Answer >>
Hot Definitions
  1. Receivables Turnover Ratio

    Receivables turnover ratio is an accounting measure used to quantify a firm's effectiveness in extending credit and in collecting ...
  2. Treasury Yield

    Treasury yield is the return on investment, expressed as a percentage, on the U.S. government's debt obligations.
  3. Return on Assets - ROA

    Return on assets (ROA) is an indicator of how profitable a company is relative to its total assets.
  4. Fibonacci Retracement

    A term used in technical analysis that refers to areas of support (price stops going lower) or resistance (price stops going ...
  5. Ethereum

    Ethereum is a decentralized software platform that enables SmartContracts and Distributed Applications (ĐApps) to be built ...
  6. Cryptocurrency

    A digital or virtual currency that uses cryptography for security. A cryptocurrency is difficult to counterfeit because of ...
Trading Center