Stock Market Investing with a Margin Account

Stock market investing with a margin account involves borrowing money for the purchase of stock. Essentially, it is a loan from your broker to give you the opportunity to purchase more stock than you might otherwise be able to afford. When buying on margin, you are only paying cash for some of the investment and borrowing to finance the rest.

Cash Account vs. Margin Account

There are two ways an investor can buy stocks: cash or margin. With a margin account purchase, the investor only pays a portion of the purchase price and borrows the rest from the broker, paying interest on the loan. Under this arrangement, the stocks become the collateral to secure the loan with any dividends earned from the stocks going toward interest payments.

Margin Accounts Are About Leverage

Just like a company might borrow money to invest in its operations and growth, an investor can borrow money to use toward investing. This leverage can dramatically increase your profit.

To illustrate the benefit, let’s say you purchased a stock for $20 per share, and the price quickly rose to $30 per share. With a cash account purchase you would a make 50% return on your investment (less brokerage fees). If you had instead purchased on margin and borrowed $20 from the broker, your return would be 100%. You would then owe your broker $10 per share plus interest.

Opening a Margin Account

To trade on margin, you first open a margin account with an initial investment of at least $2,000. Some firms require more than this. With the account operational, you can borrow up to 50% of the purchase price of a stock but you can borrow less if you choose. Some brokerage firms require you to deposit more than 50% of the purchase price. The portion of the purchase price that you deposit is called the “initial margin”.

The Risks of Buying On Margin

The risks inherent to borrowing money are there with purchasing on margin. You are responsible for any interest charges you accumulate and your marginable securities act as collateral. You should also know that the Federal Reserve Board determines which stocks can be bought on margin. Penny stocks and stocks traded over-the-counter, for example, may not be allowed.

There is also the threat of a margin call, which is issued when the margin posted in the account is below the minimum requirement. The investor then has to either increase the margin deposited, or they can close out their position by selling the securities they own.

More about the risks of trading with a margin account

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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