Margin Account

What is a Margin Account?

A margin account is a brokerage account type that allows investors and traders to borrow money from their broker to purchase securities like stocks and futures contracts. It provides leverage by letting investors trade with more money than just their own cash balance.

The broker essentially lends the customer cash using the account’s securities and cash as collateral for the loan or “margin loan”. This amplifies both potential gains and losses.

How Margin Accounts Work

With a margin account, investors must meet an initial margin requirement by depositing a minimum amount, typically at least 50% of the total purchase price. The rest is covered by borrowing from the broker.

As the securities fluctuate in price, the account is subject to ongoing maintenance margin requirements. Margin accounts provide leverage that heightens potential returns but also losses if the trade moves against the investor.

Margin Requirements and Rates

Regulatory margin requirements set minimum amounts, like 50% of the purchase price for stocks. Certain securities have higher requirements. Brokers can impose higher “in-house” requirements. Margin accounts charge interest at a variable rate on the loan amount, with rates potentially over 10% annually. Interest accrues until the loan is repaid.

Margin Account Risks

The biggest risk with margin is being subject to a margin call. This happens if account equity drops below the maintenance requirement, requiring a deposit of cash or securities to meet the minimum. If not met, the broker can liquidate positions to pay off the loan, locking in losses. Margin amplifies potential losses more than gains.

Margin Account Rules

There are many specific rules and requirements governing margin accounts, such as minimum account values to open/maintain one, eligible securities, margin rates, and prohibited practices like free-riding. Rules aim to prevent excessive leverage and risk. Violations can result in account restrictions or termination.

Margin Account Examples

All major brokers like Interactive Brokers and Fidelity, as well as day trading brokers like Cobra Trading, offer margin accounts and publish their specific interest rates, margin requirements, account minimums, and approved security lists for margin trading.

Margin vs. Cash Accounts

Unlike a cash account, where all trades use the investor’s own money, a margin account provides leverage by borrowing funds from the broker. This allows for higher returns but also magnifies potential losses. Margin accounts have interest costs and risk of margin calls that cash accounts avoid.

Using Margin Responsibly

Financial advisors recommend only using margin accounts for active traders pursuing short-term strategies (e.g., day trading and high-frequency trading), not long-term investors. Margin amplifies volatility and losses in down markets.

Experts advise maintaining enough capital to withstand adverse moves and margin calls, using margin selectively, and having an exit strategy for losing positions.

Alexander Voigt, CEO
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Alexander Voigt is the founder of DayTradingZ, was a regular contributor to Benzinga and has been featured and quoted on leading financial websites such as Investors.com, Capital.com, Business Insider and Forbes.