When it comes to trading and investing, margin is the borrowed money that some traders use to execute their strategy. Buying assets on margin can help magnify your gains and returns — but it can do the same with your losses.
When you buy on margin, you’re purchasing assets using money that you borrow from your broker. Read on to learn more about what it means to trade on margin, the definition of margin trading, and how buying on margin works.
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What is Margin Trading?
Margin trading, or buying on margin, means to buy on credit. Or, to borrow funds to pay for an investment in order to buy more of an asset than you’d otherwise be able to. Margin trading usually means that a trader or investor is borrowing money, via a margin loan, from their brokerage to buy a stock.
For instance, if a trader wanted to buy Stock XYZ at the market open because they thought it was going to increase in value that day, they could use margin to buy it without putting up the full price of their order. They’re executing the trade using leverage. The risk, of course, is that Stock XYZ doesn’t appreciate in value during the day, but rather loses value.
Buying on Margin Example
Here’s an example of how buying on margin may look in practice:
Say you want to buy $10,000 of Stock X, but you only have $5,000 in cash in your brokerage account. You can use margin to make up the difference by borrowing $5,000 from your brokerage in margin. Again, depending on your brokerage, you may just need to stipulate how much you’d like to purchase on margin when verifying the trade.
Depending on your brokerage’s margin requirements, you’ll need to maintain a certain balance in your account. Otherwise, you may run into a nasty situation in which your brokerage issues a margin call, requiring you to deposit more money into your account.
But as long as you’re staying above maintenance thresholds, buying on margin likely only requires an additional step when executing a trade.
How Does Margin Trading Work?
Margin trading requires you to have a margin account with your brokerage. To get a margin account, first you’ll need a cash account, which allows you to deposit cash and buy securities. Then, on top of that, you can apply to open a margin account, which gives you the ability to purchase additional securities with a line of credit. In this case, the cash or securities the trader already owns can act as collateral.
You can use your margin account to borrow money from the broker, on top of the cash you have in your account, to buy stocks or other investments. The ability to buy more investments than you can pay for with cash affords investors a degree of leverage in the markets.
Leverage means investing using borrowed money, as you’re able to make a bigger investment with a smaller amount of capital. There are a lot of variables at play, however, before a brokerage will allow you to start buying on margin.
Basic Margin Requirements
When it comes to funding margin accounts, the Securities and Exchange Commission (SEC), FINRA and other bodies have set some rules:
• Initial margin: Generally you can borrow up to 50% of the cost of the securities you plan to buy. This means 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 much less than this.) Your buying power may vary, depending on the value of your portfolio on any given day.
• Minimum margin: There is a minimum requirement of $2,000 in order to start trading on margin, according to FINRA, though some brokerages may require more.
• Maintenance margin: Once you’ve bought investments on margin, under FINRA rules the equity in the account must not fall below 25% of the current market value of the securities in the account. If it falls below this level, either because you withdrew money or because your investments have lost value, you may get a margin call from your brokerage.
How to Buy on Margin
Before you can start margin buying using your brokerage account, your brokerage will need to approve you to do so. And that may involve meeting some basic requirements, as mentioned above.
Once you’ve checked all the boxes and have received a margin account from your brokerage, you can start buying stock on margin. Of course, the specifics may depend on your brokerage, but in general, you can simply tap into your buying power when executing a trade. You may be given the option to use margin or cash in your account when verifying your trade, too.
There are also some investments that you can not purchase with margin, these are called “non-marginable securities.”
Margin Interest Rates
Another important thing to remember is that margin trading isn’t free. Brokerages charge interest on margin loans when you borrow from them, much like a credit card company. So, borrowing has its costs when trading, too.
Margin rates can vary from one brokerage to the next, and there are different factors that affect the rates brokerages charge. For example, many brokerages use a tiered rate schedule based on the amount of the margin loan.
Typically there’s no deadline to repay the borrowed funds, but you must at least pay the interest on the margin loan that’s due. And most margin accounts require that you keep your account value above a certain threshold (more on that below).
What Is a Margin Call?
A margin call happens when the value of an investor’s margin account dips below the brokerage’s maintenance margin. The “call” is a request for the investor to meet the maintenance margin and usually happens when a security the investor purchased decreases in value.
A margin call requires the account owner to post additional collateral — which can be in the form of marginable securities or cash — to meet the call. If the call is not met quickly enough, the broker can liquidate your positions.
Once you’ve familiarized yourself with margin trading lingo and some basic stock market terms, it might be helpful to understand some of the potential benefits and risks of margin trading.
Risks and Benefits of Margin Trading
There are some clear benefits to margin trading. But there are some big risks, too.
Risks of Margin Trading
• Leverage risk (potential to magnify losses)
• Margin calls
• Interest charges add to costs
The biggest risk when trading on margin is that your investments could lose value — meaning you’re now underwater on your trade, and are in debt to your brokerage. Plus, there are interest charges on the margin loan to contend with. Unlike a cash account, the traditional way to buy stocks or other investments, losses in a margin account can actually extend beyond the initial investment.
Another potential negative aspect of margin trading is getting a margin call. Investors might have to put additional funds into their account on short notice if a margin call is triggered because the investment lost value. Additionally, a drop in value might mean an investor has to sell off some or all of the investment, likely at an inopportune time.
The SEC warns investors that if some of their stock must be sold to cover a margin call, the investor usually does not get to decide which investments are sold, and they may get little to no notice that their securities are going to be sold to cover a margin call. They also advise investors to be aware that a brokerage might increase margin requirements with little notice, also likely at an inopportune time.
Benefits of Margin Trading
• Leverage (potential to magnify gains)
• Easy line of credit for investing
• Interest rates tend to be low (an tax-deductible)
The most obvious benefit of margin trading is that it allows investors to use leverage, and potentially increase returns without putting up additional capital. This could possibly help boost returns if the price of the stock or other investment purchased with a margin trade goes up.
A margin account can also act as an easy line of credit for trading (much more so than other potential avenues for borrowing), and even though there are interest charges, they tend to be low, and possibly tax-deductible.
Another potential advantage of margin trading might be a complicated trading method called short selling. The rules for short selling with a margin account can get even more complicated than a traditional margin trade. For instance, Regulation T of the Federal Reserve Board requires margin accounts to have 150% of the value of the short sale when the trade is initiated.
|Can leverage assets (potential to magnify gains)||Leverage risk (potential to magnify losses)|
|Easy line of credit for investing||Margin calls|
|Interest rates tend to be low (an tax-deductible)||Interest charges add to costs|
Margin trading is a risky tool that some traders use to increase their potential profits. It involves borrowing money from a broker in order to make investments. Margin trading can boost returns in a bull market, but can magnify losses in a bear market.
If you’re interested in opening a margin account, try SoFi margin investing. At 2.5% interest*, you can tap into your portfolio and increase your buying power at one of the most competitive rates in the industry. Though high risk, margin investing could potentially result in high reward.
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