Margin Account

What Is a Margin Account?

A margin account is a brokerage account in which the broker loans the customer cash to purchase stocks or other financial products. The loan in the account is collateralized by the securities purchased and cash, and it accompanies a periodic interest rate. Since the customer is investing with borrowed money, the customer is utilizing leverage which will amplify profits and losses for the customer.

How a Margin Account Works

In the event that an investor purchases securities with margin funds and those securities value in value past the interest rate charged on the funds, the investor will earn a better total return than if they had just purchased securities with their own cash. This is the advantage of utilizing margin funds.

On the downside, the brokerage firm charges interest on the margin funds however long the loan is outstanding, expanding the investor's cost of buying the securities. Assuming the securities decline in value, the investor will be underwater and should pay interest to the broker what's more.

On the off chance that a margin account's equity dips under the maintenance margin level, the brokerage firm will make a margin call to the investor. Inside a predetermined number of days — typically in the span of three days, albeit in certain circumstances it could be less — the investor must deposit more cash or sell a stock to offset all or a portion of the difference between the security's price and the maintenance margin.

A brokerage firm has the privilege to ask a customer to increase the amount of capital they have in a margin account, sell the investor's securities on the off chance that the broker feels their own funds are at risk or sue the investor in the event that they don't satisfy a margin call or on the other hand assuming they are carrying a negative balance in their account.

The investor can possibly lose more money than the funds deposited in the account. Thus, a margin account is just suitable for a sophisticated investor with an intensive comprehension of the extra investment risks and requirements of trading with a margin.

A margin account may not be utilized for buying stocks on margin in a individual retirement account, a trust, or other fiduciary accounts. Likewise, a margin account can't be utilized with stock trading accounts of under $2,000.

Margin on Other Financial Products

Financial products, other than stocks, can be purchased on margin. Futures traders likewise often use margin, for instance.

With other financial products, the initial margin and maintenance margin will shift. Exchanges or other regulatory bodies set the base margin requirements, albeit certain brokers might increase these margin requirements. That means the margin might differ by broker. The initial margin required on futures is typically much lower than for stocks. While stock investors must put up half of the value of a trade, futures traders may simply be required to put up 10% or less.

Margin accounts are required for most options trading strategies too.

Illustration of a Margin Account

Expect an investor with $2,500 in a margin account needs to buy Nokia's stock for $5 per share. The customer could utilize extra margin funds of up to $2,500 supplied by the broker to purchase $5,000 worth of Nokia stock, or 1,000 shares. In the event that the stock appreciates to $10 per share, the investor can sell the shares for $10,000. Assuming they do as such, in the wake of repaying the broker's $2,500, and not including the original $2,500 invested, the trader profits $5,000.

Had they not borrowed funds, they would have possibly made $2,500 when their stock doubled. By taking double the position the potential profit was doubled.

Had the stock dropped to $2.50, however, all the customer's money would be gone. Since 1,000 shares * $2.50 is $2,500, the broker would tell the client that the position is being closed except if the customer puts more capital in the account. The customer has lost their funds and can never again keep up with the position. This is a margin call.

The above situations accept there are no fees, be that as it may, interest is paid on the borrowed funds. Assuming that the trade required one year, and the interest rate is 10%, the client would have paid 10% * $2,500, or $250 in interest. Their genuine profit is $5,000, less $250 and commissions. Even assuming that the client lost money on the trade, their loss is increased by the $250 plus commissions.

Features

• While trading stocks, a margin fee or interest is charged on borrowed funds.
• Margin increases the profit and loss capability of the trader's capital.
• A margin account typically permits a trader to trade other financial products, like futures and options (whenever approved and accessible with that broker), as well as stocks.
• A margin account permits a trader to borrow funds from a broker, and not have to put up the whole value of a trade.