Margin Trading

Margin Trading, also known as buying on margin is a mechanism of borrowing money from a broker to purchase stock. For margin trading, a trader needs to have a “margin account”, in which the broker lends the trader certain amount of cash to purchase the securities, and the broker uses these securities purchased as collateral for the loan. The broker charges interest on the loan to the investor. As the interest charges accrue over time, debt level increases as the time passes. Therefore, buying on margin is mainly used for short-term investment.

For example, let us say that the margin account has a 50% margin available, then it means that if you deposit $1000 in your margin account then you have $2000 worth of “buying power”. As you have put up 50% of the purchase price and the other 50% is given as loan to you from the broker.

Minimum Margin: Before trading on margin, according to FINRA, a trader has to deposit with his brokerage firm a minimum amount known as “minimum margin”. The amount of minimum margin may vary from broker to broker. The NYSE and NASDAQ require the investors to deposit a minimum margin of $2000 in cash or securities to open a margin account.

Initial Margin: According to the regulation of the Federal Reserve Board, a trader may borrow up to 50% of the purchase price of equity securities that can be purchased on margin. This is known as the “initial margin”. Some firms may require a deposit of more than 50% of the purchase price.

Maintenance Margin: There is a minimum account balance that has to be maintained before the broker asks the trader to deposit more funds or to sell stocks to pay down the loan. This is known as the “maintenance margin”. According to FINRA maintenance margin has to be at least 25% of the total market value of the securities purchased on margin.