As an investor, you naturally want to maximize the return on your investments. Trading stocks on margin is one way of increasing the potential return on your investments, although margin buying does carry greater risk. There are regulatory limits for trading stock on margin. Your broker may impose additional requirements and limits.
When you buy stock on margin, you borrow part of the money from your broker. The money you put up is called your margin. By borrowing, you can buy more shares and so increase your potential profit. The Federal Reserve Board sets a minimum margin requirement of 50 percent of the market value of the shares you buy. Self-regulating bodies like the Financial Industry Regulating Authority (FINRA) and the New York Stock Exchange also have rules governing margin transactions that your broker must follow. However, brokers may impose more stringent requirements if they wish.
To trade stock on margin, you must open a brokerage account with borrowing privileges, called a margin account. FINRA rules say you must have at least $2,000 in your margin account or the total value of the stock you want to buy on margin, if less than $2,000. For day traders the minimum is usually $25,000. Again, your broker may require more. You have to sign a margin agreement that makes all cash and securities in your margin account collateral for the money you borrow.
Suppose you want to buy 300 shares of a stock on margin at a price of $50 per share. Your broker is likely to require more margin than the FRB minimum, especially if the market is volatile. The total value of the stock is $15,000. If your broker asks for a 60 percent margin, you must put up $9,000. Your broker loans you the remaining $6,000 and charges you interest for the use of the money.
Once you have purchased shares of stock on margin, you have to meet a minimum maintenance requirement. For the New York Stock Exchange, the minimum maintenance requirement is 25 percent. If the stock you bought falls in price, you still owe the broker the money you borrowed, so the loss comes out of your equity. If the percentage of equity falls below 25 percent or your brokers maintenance requirement, if greater, your broker can sell the shares and any other securities in your account to recover the money you borrowed. Normally, brokers will issue a margin call so you have a chance to deposit more money in your account. However, brokers are not required to give you a margin call and may sell the stock without doing so.
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