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When you buy on margin, you’re purchasing securities with funds that you borrow from your broker: a technique also known as using leverage.
Using a margin loan, or buying on margin, allows investors to place bigger bets. This can lead to bigger gains, or steeper losses. Given this, buying on margin is considered a high-risk trading strategy.
Unlike buying securities with cash, margin trading is a sophisticated strategy that’s available only to qualified investors who are screened by their broker and approved for a margin account.
Key Points
• Buying on margin allows you to purchase securities using funds borrowed from your broker, a technique also known as using leverage. It’s considered a high-risk trading strategy.
• Using a margin loan allows investors to place bigger bets, which can lead to bigger gains or steeper losses.
• Margin trading is a sophisticated option available only to qualified investors.
• Qualified investors must be screened by their broker and approved for a margin account.
• Margin accounts are subject to stringent rules and requirements, including the minimum cash amount needed to place trades.
What Does Buying on Margin Mean?
Buying on margin when investing online or through a traditional brokerage is a sophisticated strategy where qualified investors purchase securities using money that they’ve borrowed from their brokerage.
Buying on margin means that investors can place bigger trades than they could with just their available cash. But a margin account is only available to qualified investors who meet certain criteria.
Being able to buy more with less (a.k.a., leverage) means there is potential for bigger gains if a trade moves in the desired direction. But margin trading also includes the risk of steep losses if a trade moves in the wrong direction.
That’s why investors can only borrow up to a certain percentage of the total amount of the trade; they must keep a collateral in the margin account, which can include equities or cash. Traders must also maintain a minimum margin balance, known as the maintenance margin, in their accounts to cover potential losses.
Margin Is a Loan
Using margin is effectively a type of loan. You have to repay the margin loan, plus interest and any fees — no matter whether you’ve gained or lost money on a trade. Thus, it’s possible to lose more than the original amount you invested. Margin interest rates and other terms are decided by your broker. Using margin comes with strict requirements investors must follow.
How Does Buying on Margin Work?
Investing with an ordinary cash account vs. margin account, means that your broker withdraws available funds to execute a trade. Thus every cash trade is secured 100% with the money in your account, and your broker isn’t subject to any risk.
With a margin trading account, however, a percentage of each trade is secured by available cash, while the rest is covered with funds you borrow from your broker. This is buying on margin.
The Rules Governing Margin Accounts
Margin accounts are highly regulated. First, investors typically need to deposit a minimum of $2,000 into their margin account to be eligible for borrowing, and must provide 50% (or more) of the purchase price of a security to execute the trade. This is known as initial margin.
Investors are then required to keep a minimum amount of cash or equity in their accounts, known as maintenance margin.
Generally, you can borrow up to 50% of the securities you plan to buy. So, if you have $5,000 in cash or equities in your margin account, you can borrow another $5,000 to purchase up to $10,000 of securities on margin.
You can trade various types of securities in a margin account, it’s not only for trading stocks. It’s also possible to trade derivatives, such as options or futures.
Some types of securities cannot be bought using margin. Typically, low liquidity securities that can also be volatile, such as IPO shares or penny stocks, are not marginable.
Recommended: Leverage vs. Margin
Opening a Margin Account
Once you understand how a margin account works, and you’ve been approved by your brokerage, it’s possible to open and fund a margin account and begin using margin.
The approval process for a margin account may include a review by your broker, signing a margin agreement that spells out your understanding of the potential margin trading risks, and depositing the initial margin amount.
Once added, the margin feature is subject to FINRA and SEC rules, as well as any requirements traders must meet for their individual brokerage account. Brokerage policies may be stricter than industry regulations.
Initial Margin and Regulation T
According to Regulation T, the initial margin requirement is 50% of the initial trade amount for new purchases. For example, in order to buy $5,000 worth of Company A stock on margin, you’d need a minimum of $2,500 in cash or equities in the account.
In addition, using the margin feature requires a baseline of $2,000, as mentioned above.
Maintenance Margin Requirements
Traders also have to follow maintenance margin guidelines, which requires them to keep a certain amount of cash or equity relative to their trades. According to FINRA rule 4210, the maintenance margin requirement is 25% equity — investors must keep at least 25% equity in the account — but some brokerages set the bar higher: to 30% or 40% or more.
Using the above example, assume that an investor deposits $2,500 in cash and borrows $2,500 to purchase marginable securities. Let’s say the value of these securities drops, and the investment is now worth $3,000 instead of $5,000. When the margin loan of $2,500 is subtracted from $3,000, there is a remaining balance of $500.
This means the trader has $500 in equity, minus any interest and fees, and does not meet the 25% maintenance margin requirements.
The Dreaded Margin Call
What happens when the margin account drops below the maintenance margin threshold?
If the investor doesn’t bring the account balance up to the required amount in a specified time, the brokerage may make a margin call. This would require the investor to deposit enough cash to continue trading on margin. If an investor can’t do so, the brokerage can sell securities from the account, with or without the investor’s permission, to recoup the negative margin balance.
Pros and Cons of Buying on Margin
Margin trading may sound straightforward, but it’s a high-risk strategy because of the potential for steep losses, and the need to repay the margin loan regardless.
Potential Benefits of Margin Trading
Using leverage offers investors the ability to take bigger positions using less cash. This in turn can lead to bigger gains, if the trade moves in the right direction.
Having additional liquidity also means that investors don’t have to sell other holdings to free up cash for a trade.
Another benefit of margin trading is that as long as traders meet the maintenance margin and other requirements, there is no set repayment schedule for repaying margin loans. That said, there is always
Key Risks of Margin Trading
Margin trading comes with the potential for the risk of steep losses, owing to the fact that you can lose your cash investment as well as the amount you borrowed.
This debt includes the added cost of interest on the margin loan. The margin interest rate is set by your brokerage.
Finally, there’s the risk of a margin call if the value of your equity falls below the minimum requirement. If that happens and the deficit isn’t closed within a specified period (usually a few days), you could face a margin call — which is your broker’s demand for the additional funds.
Failure to meet a margin call can result in a forced sale of your assets, and potentially other fees or penalties.
Alternatives to Margin Trading
Margin trading isn’t for everyone. Here are some alternative types of investing, ranging from everyday investment strategies to advanced options that may entail higher risk.
• Long-term investing: Buy-and-hold strategies that typically rely on a standard cash investing account come with less risk than using margin. And long-term strategies may produce steadier returns over time.
• Fractional shares: Some investing platforms allow you to buy fractional shares of stocks, an increasingly common strategy. Owning fractional shares can build portfolio diversification with a lower capital outlay.
• Dollar-cost averaging (DCA): Investing a fixed amount on a regular basis (e.g. weekly, monthly, or quarterly), a strategy known as dollar-cost averaging, has been shown to help reduce the impact of volatility and help investors stay the course over time.
• Cash-secured options trading: A margin account can be used to trade options with leverage, as well. Options are a complex, high-risk form of investing, but certain options strategies, such as cash-secured puts, may limit the maximum potential loss (though these losses could still be substantial).
• Leveraged ETFs: These funds provide multiples — e.g., 2x or 3x — of an index’s daily returns. But leveraged ETFs, sometimes called geared ETFs overseas, are not designed for long-term investing, as the multiples (whether gains or losses) are typically pegged to the index’s daily performance. Leveraged ETFs come with high risk, as well.
The Takeaway
Buying on margin is a higher-risk strategy that investors must be qualified to use.
Margin trading means that investors can open bigger positions than they then can with cash alone. This means there is potential for bigger gains if a trade moves in the desired direction — or the risk of steep losses if a trade moves in the wrong direction.
Industry rules for margin accounts are strict. Investors can only borrow up to a certain percentage of the total amount of the trade; they must maintain a minimum amount of collateral in the account to cover potential losses.
If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.
FAQ
How much money do you need to buy on margin?
The initial margin amount is typically 50% of each new trade. Investors also need a minimum of $2,000 in cash or equity to add margin to their account.
What happens if you can’t pay a margin call?
If you can’t deposit the required funds to bring your account up to the maintenance margin threshold, your broker will likely sell securities in your account to meet this minimum.
Can you buy any stock on margin?
No. Only certain stocks can be bought on margin. Some stocks that are more volatile or less liquid, such as over-the-counter (OTC) or penny stocks, are not marginable.
Do you pay interest when buying on margin?
Yes. Adding margin to your brokerage account is effectively a type of loan. The brokerage sets the interest rate.
Can you lose more than you invest on margin?
Yes. Owing to the fact that you have to repay any margin funds, with interest, it’s possible to lose more than your total investment.
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Trading securities on margin loans involves high risk and costs and is not suitable for all investors. It is possible to lose more than your initial investment when using margin. Please see more details at https://www.sofi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf
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