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Investors can use margin to leverage the funds in their trading account. Find out how margin works and why trading on margin is risky.
In the context of investing, margin is money that investors deposit into a brokerage account as collateral to secure a loan from the brokerage. The investor can then buy stocks “on margin,” putting up only part of the value and borrowing the rest. Investing with borrowed money is also referred to as using leverage.
To buy on margin, you first need to open a margin account and deposit at least the minimum margin required by your brokerage or investment firm. You can then purchase stocks, borrowing a percentage of the value. How much you can finance depends on the share price and other factors. In Canada, shares trading for $1.50 or less cannot be bought on margin, while some stocks are eligible for up to 70% financing.
If the stock goes up, your profit will be enhanced by leverage. If it goes down, however, your investment firm may make a margin call, requiring you to deposit more money into your account. In some cases, it will sell your investment—and possibly other holdings in your account—to cover the loan, depending on the terms of your margin agreement. Regardless of whether your trade is a winner or a loser, you will have to pay interest on the borrowed money, in addition to the usual commissions.
Buying on margin is a risky strategy. If your investment declines significantly, you can lose not only your own money but also borrowed money you must repay.
Example: “With the $1,000 Binh had in his margin account, he bought $2,000 of a stock with a 50% margin requirement. When the stock price fell 10%, his position declined from $2,000 to $1,800. The $200 loss reduced his margin to $800, less than the 50% minimum (50% x $1,800, or $900). He received a margin call requiring him to add $100 to his account.”
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