The Security Exchange Commission allows investors to borrow part of the cost of their investments when purchasing stock. The loan percentage is called their margin. Stockholders cannot borrow more than a certain percentage of their stock costs under federal guidelines, and must keep enough cash in their margin account to pay for at least 25 percent of their equity in the stock. Individual brokerages can exceed federal guidelines but can't undercut them.
Initial Margin Limit
You may borrow up to 50 percent of the purchase price of securities to purchase them on margin. This is called the initial margin. You cannot borrow more than this amount per federal guidelines. For example, if you want to buy 1,000 shares of stock at $3.20 a share, you cannot borrow more than $1,600 to purchase the stock.
After you purchase stock, you must keep at least 25 percent of your equity in your margin account. Calculate your equity by subtracting the amount you owe your stockbroker from the stock's value. For example, if you own stock worth $3,200 and you owe your broker $1,600, your equity is $1,600. You thus must keep $400 in your margin account.
If your margin account falls below the maintenance margin, your stock broker may issue a margin call. If you get a margin call, you must deposit more money into the account to keep your stocks. If you don't do so, your stockbroker may sell some or all of your stock to increase your equity. For example, if your stock drops to a value of $1,800 and you owe $1,600, your equity becomes only $200. You need equity of $450 to keep your stock, so your broker will issue a margin call. Some brokers sell stock without issuing a margin call if your equity drops below the maintenance amount.
When you purchase stock on margin, you are taking out a loan from your broker to purchase the stock. Thus, any time you use margin, you risk financial problems. If the stock falls in value, you still have to pay back the margin plus interest even though you lost money on the stock, and if your equity falls below the maintenance margin you could lose the stock without recouping your investment.