Investors who trade using leverage, or funds they’ve borrowed from their broker, do so via a margin account. The amount of money in that account is their margin equity. Their margin equity percentage is the portion of funds in that account that they own (versus funds they’ve borrowed).
Here’s a primer on both margin equity and margin percentage – and what they both mean for investors using a margin brokerage account.
What Is Margin Equity?
A margin account is basically a stock brokerage account with a twist – the account holder can borrow up to a specific amount of money from the brokerage firm. Margin accounts can be a powerful investment tool for sophisticated investors comfortable with higher levels or risk because they have to put up less of their own money in order to make a trade. Margin equity is the amount of money in a margin trading account at any given time.
Investors can use funds in a margin account to invest in more financial securities, such as stocks, bonds, or funds, that are paid for with funds that exist in the margin account. Money in a margin account is typically in either cash or securities.
Using the value of those assets, a margin account investor can borrow up to 50% of the amount of the cash needed to buy a stock or other security.The securities broker charges interest on any money borrowed in a margin account, plus a commission for executing the trade.
The goal for any margin account investor is to earn back enough profit from a margin account trade to cover the costs of interest on the borrowed margin account funds. If an investor loses money on a margin account trade using borrowed funds, they still have to repay those funds, with interest.
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Margin Account Rules
The Financial Industry Regulatory Authority (FINRA) sets the minimum balance of a margin account at $2,000. And a brokerage firm may have its own maximum fund limits based on the ability of the investor to prove they can repay any money borrowed from the broker via a margin account.
Any time a margin buying investor wants to buy a new security and requires borrowed margin account funds to do so, the amount of cash the investor puts on the table is known as the margin requirement.
To determine an account’s margin equity, you’d first add up the cash amount borrowed from the brokerage firm and the value of “covered call” options the investor has sold.
Any unlevered assets (like cash or stocks) left in the margin account after the above assets are subtracted is margin equity.
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What Is Margin Equity Percentage?
Margin equity percentage is the portion of unlevered assets in the account. The process of calculating margin equity percentage is similar to using debt-to-equity ratios.
Here’s an example:
Let’s say the investor buys $10,000 in stocks and funds and has borrowed $5,000 in margin account funds from the broker. The value of that $10,000 investment has increased to $11,000, as the assets purchased have increased by $1,000. The margin loan hasn’t changed – it’s still $5,000. Thus, the investor margin equity in the account stands at $6,000.
If that original $10,000 investment had resulted in a $1,000 loss, the margin equity portion of the account stands at $4,000 ($5,000 – $1,000 = $4,000.)
In the example above, the equity margin percentage is represented by the investors margin equity divided by the value of the margin account.
Using the same figures in the example where the account grows by $1,000 ($10,000 + $1,000), $6,000 divided into $11,000 is 54.5%. Using the same figures where the account declines by $1,000, and the equity value of the margin account is $4,000 and divided by $9,000 (the total amount of money left in the margin account) the margin equity percentage is 44.4%.
The Importance of Knowing Your Margin Equity and Margin Equity Percentage
Knowing your margin equity and margin equity percentage can help you understand the level of risk that you’re taking in the account. That can help you determine whether you might need to make changes in order to boost your maintenance margin, or the minimum account balance needed to avoid a “margin call.”
Brokerage firms issue margin calls if an investor’s funds fall below the required maintenance margin. If you can’t meet a margin call, the brokerage firm can shut down your margin account and hold you personally responsible for any losses incurred in the account (and charge you additional fees and commissions, as well.)
Investors who choose to trade on margin should keep an eye on their margin equity and margin equity percentage as one metric on measuring the performance and investment risk of that account. A margin account with a higher equity percentage has lower levels of debt, making a margin call less likely.
If you have the experience and risk tolerance and are ready to try out trading on margin, SoFi can help. With a SoFi margin account, you can increase your buying power, take advantage of more investment opportunities, and potentially increase your returns.
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*Borrow at 8.50%. Utilizing a margin loan is generally considered more appropriate for experienced investors as there are additional costs and risks associated. It is possible to lose more than your initial investment when using margin. Please see SoFi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf for detailed disclosure information.
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