If you pay attention to finance and investment news, you might hear something from time to time about buying on margin. It may sound intriguing, being able to purchase large amounts of stocks or other securities without having to pay the full cost of them… in most cases, though, that's all of the information that is given and it leaves you to wonder exactly how buying on margin works. If you are in this situation, then the information provided below is designed to give you more details on margin trading and may help you to determine whether or not buying on margin is right for you.
Should you decide to try your hand at margin trading, do so with care… after all, there's a lot of money that can be made, but trading on margin without realizing how and what you should be doing can also cost you quite a bit of money. A Definition of Buying on Margin Before getting into the hows and whys of margin trading, it's important that you realize exactly what buying on margin really is. In essence, buying on margin is like getting a loan from your stock broker that will enable you to purchase larger amounts of stocks and securities than you might actually be able to afford at that moment. The funds that you do pay go into a special type of brokerage account known as a margin account, and act as a deposit toward the total price of the purchase. The remainder of the price must be paid to the broker, either when you sell the stocks or after a predetermined interval.
Requirements for a Margin Purchase Because of the specialized type of purchase that margin trading requires, you have to set up your margin account before being able to make any margin trades. Though the laws regarding buying on margin may vary from country to country, in most cases the setting up of a margin account requires that the brokerage has your signature on file authorizing them to set up the account. A minimum deposit is also required for a margin account, which can be in the thousands… for many brokerages, however, they instead require that at least 50% of the value of the intended purchase is used as the deposit for the margin account though some may require as high as 60% to 75% for a first purchase. The purchase made when buying on margin utilizes the value of your deposit as well as an additional amount which is borrowed from the broker… for experienced traders this can be up to 50%, though you can choose to borrow less for any trade. There may also be additional rules concerning which stocks and securities can be purchased, as well as a minimum price for any individual stock share.
Payment of Outstanding Cost As with any loan, money borrowed for a purchase on margin must be repaid in a timely manner. Usually, the money is recovered when the purchased stocks or securities are sold… the portion that was borrowed from the brokerage firm is repaid first, and the remainder then goes to the shareholder. In the case of long-term investments that are purchased on margin, however, payments may be required on regular intervals to maintain the margin loan. Should you not make the required deposits to maintain the margin and pay down the loan, the broker may require you to sell your stock so that they can reclaim their money.