The Basics
Buying on margin is borrowing money from a broker to purchase stock. You can think of it as a loan from your brokerage. Margin trading allows you to buy more stock than you'd be able to normally. To trade on margin, you need a margin account. This is different from a regular cash account in which you trade using the money in the account. By law, your broker is required to obtain your signature to open a margin account. The margin account may be part of your standard account opening agreement or may be a completely separate agreement.
Any purchase of securities on margin requires providing a deposit equal to part of the purchase price. There is no need to ask for an advance in purchasing shares. The investor merely has to deposit the sum required to cover the margin requirement. The investor may then decide whether to buy on margin, in whole or in part, or whether to pay the total purchase cost. It should be noted, however, that the margin can be used only if there is liquidity in the account.
The amount of margin, or loan, provided for share purchases is determined by the specific loan value of each stock. While some stocks may not provide the right to any loan value, others may be eligible for loans of up to 70% of market value.
In Canada and the United States, shares trading above $3.00 are generally eligible for a loan value of 50% of market value. In general, most shares trading above $5.00 and that qualify for options are eligible for a loan value of - 70%.
Some stocks fail to meet eligibility criteria and provide no right to credit or loan value. This applies in particular to any shares trading at less than $3.00 and to all shares listed on the CDNX in Canada or on the Pink Sheetor OTC BB marketsin the United States.
Click here to see a table of Desjardins Online Brokerage's margin loan values NOTE - This link will open in a new tab.You can keep your loan as long as you want, provided you fulfill your obligations. First, when you sell the stock in a margin account, the proceeds go to your broker against the repayment of the loan, until it is fully paid. Second, the overall net margin of your account must remain positive otherwise your broker will force you to deposit more funds or sell stock to pay down your loan. When this happens, it's known as a "margin call." We'll talk about this in detail in the next section.
Marginable securities in the account are collateral. Borrowing money isn't without its costs - you'll also have to pay the interest on your loan. Interest is calculated on a daily basis and posted to your account each month.
The interest charges are applied to your account unless you decide to make payments. Over time, your debt level increases as interest charges accrue against you. As debt increases, the interest charges increase, and so on.
Therefore, buying on margin is mainly used for short-term investments. The longer you hold an investment, the greater a return you need to break even.
A Buying Power Example
Let's say you deposit $10,000 in your margin account. Because you put up 50% of the purchase price (for a stock trading above $3 but is not option eligible), this means you have $20,000 worth of buying power. Then, if you buy $5,000 worth of this stock, you still have $15,000 in buying power remaining. You have enough cash to cover this transaction and thus haven't tapped into your margin. You start borrowing the money only when you buy securities worth over $10,000.
This brings us to an important point: the buying power of a margin account changes daily depending on the price movement of the marginable securities in the account. Later in the tutorial, we'll go over what happens when securities rise or fall.
FAQs
Buying on margin involves getting a loan from your brokerage and using the money from the loan to invest in more securities than you can buy with your available cash. Through margin buying, investors can amplify their returns — but only if their investments outperform the cost of the loan itself.
What is buying on the margin? ›
Buying on margin is borrowing money from a broker to purchase stock. You can think of it as a loan from your brokerage. Margin trading allows you to buy more stock than you'd be able to normally.
Which does buying on margin involve responses? ›
Buying on margin involves borrowing money from a broker to purchase stock. A margin account increases purchasing power and allows investors to use someone else's money to increase financial leverage.
What is meant by buying on margin quizlet? ›
To buy "on margin" meant that a person would purchase stocks uncredited with a loan from their broker. Later they would sell the stocks at a higher price, pay back the loan, and keep the profit.
What was buying on margin in the 1920s? ›
The concept of “buying on margin” allowed ordinary people with little financial acumen to borrow money from their stockbroker and put down as little as 10 percent of the share value.
Why is it called buying on margin? ›
Margin refers to the amount of equity an investor has in their brokerage account. "To buy on margin" means to use the money borrowed from a broker to purchase securities. You must have a margin account to do so, rather than a standard brokerage account.
What is an example of a margin? ›
For example, if a company sells t-shirts, its gross profit would be how much it made from selling the shirts minus how much the company paid for the shirts. The margin is the gross profit divided by the total revenue, which creates a ratio. You can then multiply by 100 to make a percentage.
What does buying on margin involve brainly? ›
Buying on margin refers to the practice of borrowing money from a brokerage firm to purchase securities, such as stocks. An investor may want to do this because it allows them to increase their buying power and potentially amplify their profits.
What is buying on margin a margin call? ›
This generally results from a drop in the market value of assets, such as stocks, that have been used as collateral for loans. The margin call requires a trader to either contribute additional assets as collateral or to quickly sell some of the investments they bought with borrowed money.
What is the margin buying power? ›
Margin Buying Power is the amount of money an investor has available to buy securities in a margin account. It is the total cash held by the investor in a brokerage account plus the maximum margin available to him/her. At Firstrade, an investor's margin buying power is usually twice as much as their own equity.
As with any loan, when you buy securities on margin you have to pay back the money you borrow plus interest, which varies by brokerage firm and the amount of the loan. Margin interest rates are typically lower than those on credit cards and unsecured personal loans.
What does the phrase buying on margin refers to a way of purchasing a? ›
Buying on margin is the purchase of a stock or another security with money that you've borrowed from your broker. It's an example of using leverage, which means utilizing borrowed money to increase your potential profit.
What is the best definition of investing? ›
1. : to commit (money) in order to earn a financial return. 2. : to make use of for future benefits or advantages.
What was buying on margin and why was it risky? ›
Buying on margin involves getting a loan from your brokerage and using the money from the loan to invest in more securities than you can buy with your available cash. Through margin buying, investors can amplify their returns — but only if their investments outperform the cost of the loan itself.
What effect did buying on margin have on economic growth in 1920s? ›
Buying on margin enabled investors to purchase more stock than they could previously afford and, subsequently, realize higher gains if the stock price went up. This same innovation became a weakness when stock prices fell during the 1929 stock market crash.
Is buying on margin illegal? ›
According to Regulation T of the Federal Reserve Board, you may borrow up to 50 percent of the purchase price of securities that can be purchased on margin. This is known as the "initial margin." Some firms require you to deposit more than 50 percent of the purchase price.
Why is buying on margin illegal? ›
Buying on margins of 10 percent cash was made illegal because the practice contributed to the crash of the stock market in October of 1929. In the mid to late 1920's, the economy was booming and the country was benefiting from the success of the industrial revolution.
Is buying on margin good or bad? ›
Through margin buying, investors can amplify their returns — but only if their investments outperform the cost of the loan itself. Investors can potentially lose money faster with margin loans than when investing with cash.
How does buying on margin work with Fidelity? ›
Buying securities on margin allows you to acquire more shares than you could on a cash-only basis. If the stock price goes up, your earnings are potentially amplified because you hold more shares. Conversely, if the stock moves against you, you could potentially lose more than your initial investment.
