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Margin trading is when investors borrow money to buy stock. It’s a risky trading strategy that requires you to deposit cash in a brokerage account as collateral for a loan, and pay interest on the borrowed funds.
What Is Margin Trading?
Margin trading—also known as buying on margin—allows you to use leverage to boost your purchasing power and make larger investments than you could with your own resources. But when you buy stock with borrowed money, you run the risk of racking up higher losses.
When you open a new brokerage account, you may be offered the opportunity to choose a margin account. This type of brokerage account lets you deposit cash and then borrow a larger amount of money to buy investments.
Margin trading is a type of secured lending. When you take out a loan from your broker to buy on margin, the loan is secured with the investments you buy—similarly to how you secure a home equity line of credit (HELOC) with the home itself.
Regulations limit investors to borrowing up to 50% of an investment’s purchase price. Brokerages may have other limitations on how much you can borrow for margin trading.
Let’s say you open a margin account and deposit $5,000 in cash, for example. Your broker would allow you to buy $10,000 worth of stock in the account, and they would charge you an annual interest rate on the margin loan.
Interest on margin trading is typically added to the margin balance monthly. When you sell your stock, proceeds first pay down the margin loan and what’s left goes to the account owner.
How Does Margin Trading Work?
Margin trading is strictly regulated by the Federal Reserve, the Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC). While brokers may have their own rules, here are the common regulations that govern all margin trading:
- Minimum Margin is the minimum amount you must deposit in order to buy securities on margin. FINRA requires individuals deposit at least $2,000 or 100% of the purchase price of margin securities, whichever is less. Your broker may require a larger minimum margin deposit.
- Initial Margin is the percentage of the initial purchase price covered with your own cash when buying securities on margin. The Federal Reserve’s Regulation T allows investors to borrow up to 50% of the initial purchase price of securities, although some brokers require a higher initial margin.
- Maintenance Margin is the percentage of your own …….
Source: https://www.forbes.com/advisor/investing/margin-trading/