In the investing ecosystem, the term “margin” is used to describe the money that may be borrowed from a brokerage to execute trades or a strategy. Buying assets on margin can help magnify 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. Margin trading might seem more complicated than some other ways to invest in the stock market, but it’s a method that many investors favor — especially experienced investors. If there’s one thing to know about margin trading, though, it’s that it can cut both ways, and may incur serious risks.
Table of Contents
What Is Margin Trading?
Margin trading, or “buying on margin,” is an advanced investment strategy in which you trade securities using money that you’ve borrowed from your broker to potentially increase your return. Margin is essentially a loan where you can borrow up to 50% of your security purchase, and as with most loans, a margin loan comes with an interest rate and collateral.
Trading on margin is similar to “buying on credit.” Using margin for a trade is also known as leveraging. Margin interest rates are determined by your broker, and collateral types can be stock holdings or cash. Traders must also maintain a margin balance, known as the maintenance margin, in their accounts to cover potential losses.
As noted, margin trading is a bit more complicated (and risky) than some other ways to invest in the stock market, but it’s a tactic used by many investors.
How Does Margin Trading Work?
While margin trading may seem straightforward, it’s important to understand all the parameters.
For all trades, your broker acts as the intermediary between your account and your counterparty. Whenever you enter a buy or sell trade on your account, your broker electronically executes that trade with a counterparty in the market, and transfers that security into/out of your account once the transaction is completed.
To execute trades for a standard cash account vs. margin account, your broker directly withdraws funds for a cash trade. Thus every cash trade is secured 100% by money you’ve already deposited, entailing no risk to your broker.
In contrast, with margin accounts, a portion of each trade is secured by cash, known as the initial margin, while the rest is covered with funds you borrow from your broker.
Consequently, while margin trading affords you more buying power than you could otherwise achieve with cash alone, the additional risk means that you’ll always need to maintain a minimum level of collateral to meet margin requirements.
While margin requirements can vary by broker, we’ve defined and outlined the minimums mandated by financial regulators.
| Term | Amount | Definition |
|---|---|---|
| Minimum margin | $2,000 | Amount you need to deposit to open a new margin account |
| Initial margin | 50% | Percentage of a security purchase that needs to be funded by cash |
| Maintenance margin | 25% | Percentage of your holdings that needs to be covered by equity |
💡 Quick Tip: Options can be a cost-efficient way to place certain trades, because you typically purchase options contracts, not the underlying security. That said, options trading can be risky, and best done by those who are not entirely new to investing.
Increase your buying power with a margin loan from SoFi.
Borrow against your current investments at just 12%* and start margin trading.
*For full margin details, see terms.
Example of Margin Trading (Buying on Margin)
Here’s an example of how margin trading works, or could work, in the real world. Imagine you open a margin account with $2,000 at a brokerage firm. It’s helpful to keep the maintenance margin in mind, too, when reading through this example.
Now, say you have your eyes set on Stock X, that’s trading at $100 per share. You can afford to buy 10 shares with the cash in your account. But, you want to buy more — margin allows you to do that. Given your margin account’s 50% initial margin requirement, that means you can effectively double your purchasing power.
So, you can buy 20 shares of Stock X for a total of $2,000, and $1,000 of that purchase would be buying on margin.
If Stock X appreciates in value by, say, 100% (it’s now worth $200 per share), you could sell your holdings and end up with $4,000. You could then pay back your brokerage for the margin loan, and have realized a greater return than you would have without using margin.
But the opposite can happen, too. If Stock X depreciates by 50% (it’s now worth $50) and you sold your holdings, you’d have $1,000, and owe your broker $1,000. So, you’ve wiped out your cash reserves by using margin — one of its primary risks.
To recap: In both scenarios, the margin loan balance remains the same ($1,000), while the equity value took the entire gain or loss.
Bear in mind, too, that for simplicity, this example ignores interest charges. In a real margin trade, you would need to also back out any interest expense incurred on the margin loan before calculating your return; this would act as an additional drag on earnings.
Potential Benefits of Margin Trading
As noted, margin trading has some pretty obvious benefits or advantages. Those may include the following:
• Potential to enhance purchasing power. A primary benefit of margin trading is the potential expansion of an investor’s purchasing power, sometimes exponentially. This could possibly help boost returns if the price of the stock or other investment purchased with a margin trade goes up.
• Possible lower interest rates. Benefits of margin loans might include lower interest rates relative to other types of loans, such as personal loans, if the investor is borrowing money to make trades. Plus, there typically isn’t a repayment schedule.
• Diversification. You could also use margin trading to diversify your portfolio.
• Selling short. Another potential advantage might be a complicated trading method called short selling. Margin trading might make it possible for you to sell stocks short. Short selling differs from most other investment strategies in that investors make a bet that a stock’s price will fall.
Note, however, that 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.
While the benefits of being able to buy more investments — and potentially generate larger returns — might seem appealing to some investors, there are also some potential risks to using margin. It might be worth considering these before you decide if trading on margin is right for you.
Potential Risks of Margin Trading
There are potential benefits, and there are potential risks associated with margin trading. Here are some of those risks:
• Possible loss beyond initial investment. While a primary benefit of margin trading may be increased buying power, investors could lose more money than they initially invested. 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.
For example, if an investor purchases $20,000 worth of stock with a cash account, the most they can lose is $20,000. If that same investor uses $10,000 of their own money and a margin — essentially a loan — of $10,000 and the stock loses value, they may actually end up owing more money than their initial $10,000.
• Possibility of margin call. Another potential negative aspect of margin trading is getting a margin call. Investors might need to put additional funds into their account on short notice if a margin call is triggered because the investment lost value. Moreover, a drop in value might mean an investor needs to sell off some or all of the investment, even at an inopportune time.
The SEC warns investors that they must sell some of their stock, or deposit more funds to cover a margin call. If you get a margin call, it is your responsibility to deposit more funds, add securities or sell holdings in your account. If you don’t meet the margin call after a number of warnings from your broker, then the broker has the right to sell all or some of the current positions to bring the account back up to minimum value.
💡 Quick Tip: How to manage potential risk factors in a self-directed investment account? Doing your research and employing strategies like dollar-cost averaging and diversification may help mitigate financial risk when trading stocks.
How to Get Started With Margin Trading
Typically, the first step to getting started with margin trading is to open a margin account with a brokerage firm.
Even if you already have a stock or investment account, which are cash accounts, you still need to open a margin account because they are regulated differently. First-time margin investors need to deposit at least $2,000 per FINRA rules. If you’re looking to day trade, this dollar figure goes up to $25,000 according to FINRA rules. This is the minimum margin when opening a margin trading account.
Once the margin account has been opened and the minimum margin amount deposited, the SEC advises investors to read the terms of their account to understand how it will work.
The SEC advises investors to hedge their risks by making sure they understand how margin works, understanding that interest charges may be levied by your broker, knowing that not all assets can be purchased on margin, or even communicating with your broker to get a sense if a margin account is the right tool for you.
The Takeaway
Margin trading, as discussed, means that investors are trading securities with borrowed funds from their brokers. This allows them to potentially increase their returns, but also carries the risk of ballooning losses. As with most investing strategies and vehicles, margin trading comes with a unique set of potential benefits, risks, and rewards.
Margin trading can seem a little more complicated than some other approaches to investing. As the investor, it is up to you to decide if the potential risks are worth the potential rewards, and if this strategy aligns with your goals for the future.
If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.
FAQ
Is margin trading profitable?
Margin trading can be profitable, but there are no guarantees for investors that it will be. It can also lead to outsized and substantial losses for investors, so it’s important to consider the risks and potential benefits.
What happens if you lose money on margin?
If you lose money on margin, you may have a negative balance with your brokerage, and owe the broker money. You may also be subject to interest charges on that balance, too.
Should beginners trade on margin?
It’s best to consult with a financial professional before trading on margin, but generally, it’s likely that professionals would recommend beginners do not trade on margin.
How do you pay off margin?
Typically, if you have a negative balance in your margin account, you can reduce or pay it off by simply depositing cash into your account, or selling assets.
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