Key Takeaways
- Borrow funds using securities as collateral.
- Leverage amplifies gains and losses.
- Minimum $2,000 to open; 50% initial margin.
- Margin calls require restoring minimum equity.
What is Margin Account?
A margin account is a brokerage account that allows you to borrow money from your broker using your securities as collateral to buy additional stocks or other investments. This borrowing amplifies your potential gains as well as losses, distinguishing it from a cash account where all purchases require full upfront payment.
By leveraging your portfolio, you can increase your buying power but also assume greater risk, subject to rules set by regulators and brokers.
Key Characteristics
Margin accounts have distinct features that impact your investing experience:
- Leverage: Typically, brokers allow you to borrow up to 50% of the purchase price under Regulation T rules.
- Minimum balance: You must maintain at least $2,000 in cash or eligible securities to open a margin account.
- Maintenance margin: Brokers require you to keep equity between 25% and 40% to avoid margin calls.
- Interest charges: You pay interest on borrowed funds until the loan is repaid.
- Short selling: Margin accounts enable short selling, which is not allowed in cash accounts.
- Regulatory compliance: You agree to broker and regulator rules by signing a margin agreement.
How It Works
When you open a margin account, you can borrow funds secured by your portfolio to purchase securities. For example, with $5,000 in equity, you may buy $10,000 worth of stocks, increasing your exposure but also your risk.
Brokers charge interest on the borrowed amount and monitor your account to ensure you meet minimum equity requirements. If your account equity falls below the maintenance margin, you face a margin call and must quickly restore the balance by depositing cash or selling assets.
This borrowing functions like a line of credit, distinct from a T-account cash account, and can magnify both profits and losses depending on market movements.
Examples and Use Cases
Margin accounts are useful for investors seeking enhanced returns or flexibility:
- Airlines: Investors might use margin to increase positions in stocks like Delta or American Airlines during market dips.
- Growth stocks: Leveraging margin can amplify gains from volatile stocks, a tactic detailed in our guide on best growth stocks.
- Online brokers: Choosing a broker with competitive margin rates is critical; see our best online brokers guide for options.
Important Considerations
Using a margin account requires careful risk management. The potential for margin calls means you must monitor market conditions and your account equity closely to avoid forced liquidation at unfavorable prices.
Interest expenses and broker policies vary, so understanding your broker’s terms and maintaining sufficient equity are essential. Margin accounts are not generally available for retirement accounts, and leverage can magnify losses as much as gains.
Final Words
A margin account lets you amplify your investment potential but also increases risk through borrowed funds and interest charges. Before opening one, carefully compare broker terms and calculate whether the costs and risks align with your strategy.
Frequently Asked Questions
A margin account is a brokerage account that lets you borrow money from your broker using your existing securities as collateral to buy more stocks or other investments. This can increase your potential gains, but also your losses.
When you buy on margin, your broker lends you funds typically up to 50% of the purchase price, based on Federal Reserve rules. You pay interest on the borrowed amount until you repay it, and you don’t have a fixed repayment schedule but must maintain minimum equity levels.
To open a margin account, you usually need at least $2,000 in cash or eligible securities. This initial deposit acts as your equity and allows you to borrow additional funds to increase your buying power.
Maintenance margin is the minimum equity percentage you must keep in your margin account, typically between 25% and 40%. If your equity falls below this level due to market losses, you’ll receive a margin call requiring you to deposit more funds or sell assets.
If your account equity drops below the broker’s maintenance margin, you’ll get a margin call. You’ll need to quickly add cash or securities or sell holdings; otherwise, the broker can sell your investments to cover the loan, possibly at a loss to you.
Yes, margin accounts allow short selling, which means you can borrow shares to sell them and buy back later at a lower price. This strategy isn’t allowed in cash accounts.
Yes, if your margin account balance is under $25,000, pattern day trading rules limit your buying power, usually capping it at four times your maintenance margin excess. This is meant to reduce risk for frequent traders with smaller accounts.
Generally, margin accounts are not allowed for retirement accounts like IRAs. Retirement accounts usually only allow cash accounts without borrowing due to regulatory restrictions.
