What Is a Margin Account and How Does Margin Trading Work?

Qualified investors may be able to borrow money from a brokerage via a margin account to place bigger trades than they could with cash on hand, or to take a short position.

Most brokerages offer the option of making a taxable account a margin account, but only to qualified investors. Margin trading can amplify gains as well as losses, and it’s considered a high-risk strategy.

Because margin trading is essentially a loan from a brokerage, margin loans must be repaid with interest, plus any fees. Thus, when using a margin account it’s possible to lose more than you originally invested.

What Is a Margin Account?

As mentioned, a margin account is used for margin trading, which involves borrowing money from a brokerage to place trades or investments. A margin account allows you to borrow from the brokerage to purchase securities that are worth more than the cash you have on hand.

In this case, the cash or securities already in your account act as your collateral.

Margin accounts are generally considered to be more appropriate for experienced investors, since trading on margin means taking on additional costs and risks.

How Does a Margin Account Work?

Just as you can borrow money against the equity in your home, you can also borrow money against the cash or equity in your portfolio. Investors in the U.S. stock market who meet certain criteria can use borrowed funds to place trades (a.k.a., leverage) or to take a short position.

Some types of securities are eligible for margin, but some are not. Typically, highly volatile or low liquidity securities, such as IPO shares or penny stocks, are not marginable.

Margin accounts are highly regulated. 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.

Investors are then required to keep a minimum amount of cash or equity in their accounts, known as maintenance margin.

The Financial Industry Regulatory Authority, or FINRA, requires a minimum maintenance margin of 25% as an industry baseline. But individual brokerage firms may have their own requirements.

Cash Account vs. Margin Account

When defining a margin account, it helps to understand its counterpart — the cash brokerage account.

With a cash brokerage account, you can only buy as many investments as you can cover with cash. If you have $10,000 in your account, you can buy $10,000 worth of securities.

Ordinary cash brokerage accounts are not available for margin, generally speaking, because margin accounts must meet more stringent criteria.

Likewise, certain accounts like retirement accounts (such as IRAs or 401ks) generally operate like cash accounts; you cannot use leverage to make investments in retirement accounts.

There is something called limited margin in a Roth IRA or traditional IRA, but this refers to the practice of using unsettled funds to purchase securities; not the use of leverage.

Using Margin

To open a margin account, investors must make a minimum deposit of $2,000, or 50% of the securities they want to buy (whichever is the larger amount); sign an agreement with their brokerage; and pass a basic screening for investment knowledge, credit history, and so on.

The Federal Reserve’s Regulation T requires a minimum 50% initial margin deposit to place a trade. So, a qualified investor can typically borrow up to twice the amount of the collateral in their account to buy more shares (the exact terms depend on the brokerage). As noted above, a brokerage could require a higher amount as collateral.

For example, let’s say a trader wants to purchase 500 shares of Company A at $50 per share, but they only have $12,500 in cash. The trader may be able to use margin, which allows them to borrow another $12,500 to open a $25,000 position.

This amount is known as the initial margin requirement. In addition, investors must maintain a minimum balance in their margin accounts, known as maintenance margin, which is 25% of the total value of the securities in the account.

Recommended: What Is After Hours Trading?

Margin Account Rules and Regulations

To recap what a margin account is and how margin trading works: The Securities and Exchange Commission (SEC), FINRA, and other industry bodies have set some rules:

•   Minimum margin: There is a minimum margin requirement before you can start trading on margin. FINRA requires that you deposit $2,000 or 50% of the purchase price of the stocks you plan to purchase on margin, whichever is greater.

•   Initial margin: Your margin buying power has limits: Generally, you can borrow up to 50% of the cost of the securities you plan to buy. This means, for example, that if you have $10,000 in your margin account, you can purchase up to $20,000 of securities on margin. You would spend $10,000 of your own money and borrow the other 50% from the brokerage. (You can also borrow less.) Your buying power varies, depending on the value of your portfolio on any given day.

•   Maintenance margin: Once you’ve bought investments on margin, regulators require that you keep a minimum balance in your margin account. Under FINRA rules, your equity in the account must not fall below 25% of the current market value of the securities in the account.

If your equity drops below this level, either because you withdrew money or because your investments have fallen in value, you may get a margin call from your brokerage.

Example of Margin Trading

An example of using a margin account could look like this: Say you have a margin account with $5,000 in cash in it. This allows you to use 50% more in margin, so you actually have $10,000 in purchasing power. You’re able to actually make a trade for $10,000 in securities, using $5,000 in margin.

In effect, margin extends your purchasing power as an investor, and you’re not obliged to use it all.

Benefits of a Margin Account

For an experienced investor who executes various day trading strategies, having a margin account and trading on margin can have some advantages:

•   More purchase power: A margin account allows an investor to buy more investments than they could with cash. That might lead to higher returns, since they’re able to open bigger positions. In addition, they may be able to diversify their investments using margin.

•   A safety net: Just as building an emergency fund offers access to cash when you need it, so can a margin account. If you need funds but you don’t want to sell investments at their current price point, you can take a margin loan for short-term cash needs.

•   You can leave your losers alone: In another scenario, if you need cash but your investments aren’t doing so well, taking a margin loan allows you to keep your securities where they are instead of selling them right now at a loss.

•   No loan repayment schedule: There is typically no repayment schedule for a margin loan, so you can repay it on your own timeline, as long as your equity in the account maintains the proper threshold. Monthly interest will accrue on the loan, however, and be added to your account.

•   Potentially deductible interest: There may be tax situations in which the interest on a margin loan can be used to offset taxable income. A tax professional will tell you whether this is a move you can consider.

Risks and Drawbacks of a Margin Account

Despite the advantages, using a margin account has risks. Here are some things to consider before trading on margin:

•   You could lose substantially: While it’s possible that trading on margin can help realize greater returns if an investment does well, you will also see greater losses if an investment drops in value. And even if an investment you’ve purchased on margin loses all of its value, you’ll still have to repay the margin loan to the brokerage — plus interest.

•   There may be a margin call: If your investments drop, you must bring your account back up to the required minimum margin threshold or face what’s known as a margin call from your broker to restore the minimum allowable amount. If you don’t respond to the margin call, it’s also possible for a brokerage to sell securities in your account without alerting you.

How to Open a Margin Trading Account

Opening a margin account is not as simple as opening a cash account. You’ll likely need to sign a margin agreement with your brokerage, and meet certain criteria. You may also need to request margin for your account, depending on the requirements at your brokerage.

If you’re a beginner investor, a cash account gives you an opportunity to learn how to trade and invest, and there’s a low level of risk.

If you’re a more experienced investor and fully understand the risks of trading on margin, a margin account may offer the opportunity to expand and diversify your investments into short-term vs long-term investments.

Some financial advisors suggest that clients open margin accounts in case they need cash in a hurry. For instance, if you need money quickly, it takes time to sell investments and for the money to be deposited in your account. If you have a margin account, you can take a margin loan while your securities are being sold.

Margin and Short Selling

You also need a margin account for short selling. With short selling, you borrow a stock in your brokerage account and sell it for its current price. If the price of the stock falls — which you’re betting will happen — you repurchase shares of the stock and return it to the original owner, pocketing the difference in price.

Like trading on margin, short selling is a strategy for experienced investors and comes with a high amount of risk.

What Is a Margin Call?

If the equity in your margin account drops below a certain threshold, you may get an alert from your brokerage, known as a margin call. At this point you’re required to either deposit more money into your account, or sell securities to restore the equity that’s acting as collateral for your margin loan.

It’s worth noting that if your investment value drops quickly or significantly, you may find that your brokerage has sold some of your securities without notifying you. It’s not uncommon that investors are forced by a margin call to sell investments at an inopportune time — such as when the investment is priced at less than you paid for it. This is an inherent risk of trading on margin.

Understanding Margin Costs

Investors should also know about relevant margin costs. When you borrow money from the brokerage to buy securities, you are essentially taking out a loan, and the brokerage will charge interest.

Margin interest rates are different from company to company, and may be somewhat higher than rates on other kinds of loans.

Consider interest costs when you’re thinking about your margin trading plan. If you use margin for long-term investing, interest costs can affect your returns. And holding investments on margin means the value of your securities must hold steady.

How to Manage Margin Account Risk

If you decide to open a margin account, there are steps you can take to try to minimize the amount of risk you’re taking by using leverage:

•   Skip the dodgy investments: Trading on margin works if you’re earning more than you’re paying in margin interest. Speculative investments can be a risky portfolio move, since a swift loss in value can result in a margin call.

•   Watch your interest costs: Although there is no formal repayment schedule for a margin loan, you’re still accruing interest and you are responsible for paying it back over time, so limiting interest costs is wise.

•   Maintain some emergency cash: Having a cushion of cash in your margin account gives you a little wiggle room to keep from facing a margin call.

The Takeaway

A margin account is an account that lets you borrow against the cash or securities you own, to buy more securities or sell short. As with other lending vehicles, margin accounts do charge interest.

While margin accounts do come with risk — including the risk of losing more money than you originally had, plus interest on what you borrowed — they also offer benefits including more purchasing power and coverage for short-term cash needs.

If you’re unsure about the risks of using a margin account, it may be worthwhile to discuss it with a financial professional.

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.

Get one of the most competitive margin loan rates with SoFi, from 4.75% to 9.50%*

FAQ

Is a margin trading account right for me?

A margin account may be useful for a qualified investor, assuming they meet certain criteria in terms of experience and knowledge and risk awareness, as well as the financial capacity to use margin.

How much money do you need to open a margin account?

Before opening a trading account, investors will need a minimum of $2,000 in their brokerage account, or 50% of the desired position, per industry regulations.

Can you lose more than you invest in a margin account?

Yes. Because a margin loan must be repaid with interest, it’s possible to lose more than your original investment with a margin trade.

Do you pay interest on a margin account if you don’t use it?

No, you only pay interest on the amount you borrow from your brokerage. Note that interest rates on margin accounts may vary.

Should a beginner use a margin account?

It may be best for a beginner to stick to a cash account until they learn the ropes in the markets, as using a margin account can incur additional risks and costs.

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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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