What is a 'Margin Account'

A margin account is a brokerage account in which the broker essentially lends the customer cash to purchase securities. The loan in the account is collateralized by the securities purchased and cash, and comes with a periodic interest rate. Because the customer is investing with borrowed money, the customer is using leverage, and will magnify both losses and gains because of it.

BREAKING DOWN 'Margin Account'

A margin account lets an investor borrow money from a broker to purchase securities up to certain limits. For example, an investor with $2,500 in a margin account wants to buy Company A’s stock for $5 per share. The customer could use additional margin funds of $2,500 supplied by the broker to purchase $5,000 of Company A’s stock, or 1,000 shares. If the stock appreciates to $10 per share, the investor can sell his shares for $10,000. If he does so, after repaying the broker's $2,500, he will have profited $7,500, assuming no other costs. In reality, the investor will also have to pay interest on the margin lent to him by the broker, as well as other trading costs, so his profit will be less.

Margin Account Pros and Cons

If an investor purchases securities with margin funds, and those securities appreciate in value beyond the interest rate charged on the funds, the investor will earn a better total return than if he had only purchased securities with his own cash. This scenario is the advantage of using margin funds. On the downside, the brokerage firm charges interest on the margin funds for as long as the loan is outstanding, increasing the investor’s cost of buying the securities. If the securities decline in value, the investor will be underwater on the margin funds, and will have to pay interest to the broker on top of that. In addition, if a margin account’s equity drops below the maintenance margin, the brokerage firm will make a margin call to the investor. Within a specified number of days, typically within three days, the investor must deposit more cash or sell 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 most suitable for a sophisticated investor with a thorough understanding of the additional investment risks and requirements.

Federal Regulations on Margin Accounts

A margin account may not be used for buying stocks on margin in an individual retirement account, Uniform Gift to Minor accounts, a trust or other fiduciary accounts, as 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, 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.

RELATED TERMS
  1. Buying On Margin

    Buying on margin is the purchase of an asset by paying the margin ...
  2. Minimum Margin

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

    An excess margin deposit is cash or equity in a margin trading ...
  4. Buying Power

    Buying power is the money an investor has available to buy securities ...
  5. Long Market Value

    The long market value is the current market value of the securities ...
  6. Cash Trading

    Cash trading is a method of buying or selling securities by providing ...
Related Articles
  1. Trading

    Margin Trading

    Find out what margin is, how margin calls work, the advantages of leverage and why using margin can be risky.
  2. Managing Wealth

    What’s a Good Profit Margin for a New Business?

    Surprisingly, the younger your company is, the better its numbers may look.
  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. Investing

    Leverage: Is It Good for Your Portfolio?

    Discover the concept of financial leverage. Learn multiple ways to get leverage in your portfolio, and decide if leverage is a good idea for you.
  5. Investing

    Finding Your Margin Investment Sweet Spot

    Borrowing to increase profits isn't for the faint of heart, but margin trading can mean big returns.
RELATED FAQS
  1. What is a margin account?

    A margin account is an account offered by brokerage firms that allows investors to borrow money to buy securities. Read Answer >>
  2. What's the difference between a cash account and a margin account?

    All transactions in a cash account must be made with available cash or long positions; a margin account allows investors ... Read Answer >>
  3. What is the difference between initial margin and maintenance margin?

    Learn the difference between an initial margin requirement and a maintenance margin requirement and how these affect an investor's ... Read Answer >>
Trading Center