# Margin and Margin Trading Explained Plus Advantages and Disadvantages

## What Is Margin?

Margin trading allows investors to enhance their purchasing power by borrowing funds from a broker to acquire more assets than they could with their available cash alone. This leverage can amplify both potential returns and the risks involved. Margin represents the collateral investors deposit with brokers to cover potential losses and can be used in various financial activities such as buying securities, short selling, or trading derivatives.

When engaging in margin trading, an initial margin is required as a deposit, acting as a safeguard for the broker. Investors use their existing securities as collateral, enabling them to borrow additional funds from their brokerage. This strategy can significantly increase the potential for higher returns when market conditions are favorable, but it is crucial to understand the inherent risks, including the possibility of margin calls which may lead to significant losses if not managed properly.

In a general business context, the margin is the difference between a product or service's selling price and the cost of production, or the ratio of profit to revenue. Margin can also refer to the portion of the interest rate on an [adjustable-rate mortgage](https://www.investopedia.com/terms/a/arm.asp) (ARM) added to the adjustment-index rate.

### Key Takeaways

*   Margin trading involves borrowing money from a broker to purchase securities, thus amplifying both potential gains and losses based on market performance.
*   To trade on margin, investors need to set up a margin account, which requires an initial deposit serving as collateral and ongoing interest payments on borrowed funds.
*   Margin trading is regulated by FINRA and the SEC, which impose rules on how much investors must deposit and maintain in their accounts to manage risk.
*   Investors must be aware of the risks of margin calls, where brokers may demand additional funds or liquidate positions to maintain the account's minimum required value.
*   Margin trading incurs interest charges on borrowed funds, making it potentially costly if market conditions don't favor the investor, emphasizing its suitability for short-term investments.

![Margin](https://www.investopedia.com/thmb/mATfU0m9l5M6mx63kwUs9Vgmqfc=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/margin-Final-872dda45cc4243cc958fe841e452a1b0.jpg)

*— Investopedia / Theresa Chiechi*

## How Margin and Margin Trading Works

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. A margin account is where a broker lends you money to buy more securities than your account balance would allow.

Using margin to purchase securities is effectively like using the current cash or securities already in your account as collateral for a loan. This loan comes with interest that must be paid regularly. The investor is using borrowed money, and therefore both the losses and gains will be magnified as a result. Margin investing can be advantageous in cases where the investor anticipates earning a higher rate of return on the investment than what they are paying in interest on the loan.

For example, if you have an [initial margin](https://www.investopedia.com/terms/i/initialmargin.asp) requirement of 60% for your margin account, and you want to purchase $10,000 worth of securities, then your margin would be $6,000, and you could borrow the rest from the broker.

> **Important**
>
> The Securities and Exchange Commission has stated that margin accounts "can be very risky and they are not appropriate for everyone".

## Step-by-Step Guide to Buying on Margin

Buying on margin is borrowing money from a broker in order 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](https://www.investopedia.com/terms/m/marginaccount.asp). In a regular [cash account](https://www.investopedia.com/terms/c/cashaccount.asp), you trade using only the money you have in the account. With a margin account, you deposit cash, which serves as the collateral for a loan to purchase securities. You can use this to borrow up to 50% of the purchase price of an investment. So if you deposit $5,000, you could buy up to $10,000 in securities.

Your broker will charge interest on this loan, and you'll need to repay it. If you sell your securities, the proceeds will pay off your loan first, and you can keep what's left.

The Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC) regulate margin trading, with strict rules as to how much you must deposit, how much you can borrow, and how much you must keep in your account.

## Key Elements of Margin Trading

### Minimum Margin

By law, your broker is required to obtain your consent to open a margin account. The margin account may be part of your standard account opening agreement or may be a completely separate agreement. An initial investment of at least $2,000 is required for a margin account, though some brokerages require more. This deposit is known as the [minimum margin](https://www.investopedia.com/terms/m/minimummargin.asp).

### Initial Margin

Once the account is opened and operational, you can borrow up to 50% of the purchase price of a stock. This portion of the purchase price that you deposit is known as the initial margin. It's essential to know that you don't have to margin all the way up to 50%. You can borrow less, say 10% or 25%. Be aware that some brokerages require you to deposit more than 50% of the purchase price.

You can keep your loan as long as you want, provided you fulfill your obligations such as paying interest on time on the borrowed funds. 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.

### Maintenance Margin and Margin Call

There is also a restriction called the [maintenance margin](https://www.investopedia.com/terms/m/maintenancemargin.asp), which is the minimum account balance you must maintain before 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](https://www.investopedia.com/terms/m/margincall.asp). A margin call is effectively a demand from your brokerage for you to add money to your account or close out positions to bring your account back to the required level. If you don't meet the margin call, your brokerage can sell your holdings to meet account minimums. Your brokerage firm can do this without your approval and can choose which position(s) to liquidate.

In addition, your brokerage firm can charge you a [commission](https://www.investopedia.com/terms/c/commission.asp) for the transaction(s). You are responsible for any losses sustained during this process, and your brokerage firm may liquidate enough shares or contracts to exceed the initial margin requirement.

## Important Considerations for Margin Investors

Using margin involves borrowing, which incurs costs and uses your securities as collateral. The primary cost is the interest you have to pay on your loan. 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 the return that is needed to break even. If you hold an investment on margin for a long period of time, the odds that you will make a profit are stacked against you.

Not all stocks, ETFs, or securities can be bought on margin. Also, not all exchanges or brokers allow margin on the investment products they handle. Cryptocurrency is an example of an investment where [margin trading might be limited](https://www.investopedia.com/news/short-bitcoin/).

The [Federal Reserve Board](https://www.investopedia.com/terms/f/frb.asp) regulates which stocks are marginable. As a rule of thumb, brokers will not allow customers to purchase [penny stocks](https://www.investopedia.com/terms/p/pennystock.asp) or [initial public offerings](https://www.investopedia.com/terms/i/ipo.asp) (IPOs) on margin because of the day-to-day risks involved with these types of stocks. Individual brokerages can also decide not to margin certain stocks, so check with them to see what restrictions exist on your margin account.

> **Fast Fact**
>
> Significant margin calls may have a domino effect on other investors. Should a single major investor face a significant margin call, their forced liquidation may decrease the value of the securities held as collateral by other margin traders, putting these investors at risk of a margin call of their own.

## Pros and Cons of Margin Trading: An In-Depth Look

Advantages

*   May result in greater gains due to leverage
    
*   Increases purchasing power
    
*   Often has more flexibility than other types of loans
    
*   May be self-fulfilling opportunity cycle where increases in collateral value further increase leverage opportunities
    

Disadvantages

*   May result in greater losses due to leverage
    
*   Incurs account fees and interest charges
    
*   May result in margin calls which require additional equity investments
    
*   May result in forced liquidations which result in the sale of securities (often at a loss)
    

### Advantages

The primary reason investors margin trade is to capitalize on [leverage](https://www.investopedia.com/terms/l/leverage.asp). Margin trading boosts purchasing power by increasing available capital to buy securities. Instead of [buying securities with money you own](https://www.investopedia.com/terms/c/cash_trading.asp), investors can buy more securities using their capital as collateral for loans greater than their capital on hand.

For this reason, margin trading can amplify profits. Again, with more securities in hand, increases in value have greater consequential outcomes because you're more heavily invested using debt. On the same note, if the value of the securities posted as collateral also increase, you may be able to further utilize leverage as your collateral basis has increased.

Margin trading is also usually more flexible than other types of loans. There may not be a fixed repayment schedule, and your broker's maintenance margin requirements may be simple or automated. For most margin accounts, the loan is open until the securities are sold in which final payments are often due to the borrower.

### Disadvantages

If investors primarily enter into margin trading to amplify gains, they must be aware that margin trading also amplifies losses. Should the value of securities bought on margin rapidly decline in value, an investor may owe not only their initial equity investment but also additional capital to lenders. Margin trading also comes at a cost; brokers often charge [interest expense](https://www.investopedia.com/terms/i/interestexpense.asp), and these fees are assessed regardless of how well (or poorly) your margin account is performing.

Because there are margin and equity requirements, investors may face a margin call. This is a requirement from the broker to deposit additional funds into their margin account due to the decrease in the equity value of securities being held. Investors must be mindful of needing this additional capital on hand to satisfy the margin call.

Should investors not be able to contribute additional equity or if the value of an account drops so fast it breaches certain margin requirements, a forced liquidation may occur. This forced liquidation will sell the securities purchased on margin and may result in losses to satisfy the broker's requirement.

## Real-World Example: How Margin Trading Works in Practice

Let's say that you deposit $10,000 in your margin account. Because you put up 50% of the purchase price, this means you have $20,000 worth of [buying power](https://www.investopedia.com/terms/b/buyingpower.asp). Then, if you buy $5,000 worth of stock, you still have $15,000 in buying power remaining. You have enough cash to cover this transaction and haven't tapped into your margin. You start borrowing the money only when you buy securities worth more than $10,000. 

Note that the buying power of a margin account changes daily depending on the price movement of the marginable securities in the account.

## Beyond Trading: Various Applications of Margin

### Accounting Margin

In business accounting, margin refers to the difference between revenue and expenses, where businesses typically track their [gross profit margins](https://www.investopedia.com/ask/answers/122314/what-difference-between-gross-margin-and-contribution-margin.asp), operating margins, and net profit margins. The gross profit margin measures the relationship between a company's revenues and the [cost of goods sold](https://www.investopedia.com/terms/c/cogs.asp) (COGS). Operating profit margin takes into account COGS and operating expenses and compares them with revenue, and net profit margin takes all these expenses, taxes, and interest into account.

### Margin in Mortgage Lending

Adjustable-rate mortgages (ARM) offer a fixed interest rate for an introductory period of time, and then the rate adjusts. To determine the new rate, the bank adds a margin to an established index. In most cases, the margin stays the same throughout the life of the loan, but the index rate changes. To understand this more clearly, imagine a mortgage with an adjustable rate that has a margin of 4% and is indexed to the [Treasury Index](https://www.investopedia.com/terms/t/treasuryindex.asp). If the Treasury Index is 6%, the interest rate on the mortgage is the 6% index rate plus the 4% margin, or 10%.

## What Does It Mean to Trade on Margin?

Trading on margin means borrowing money from a brokerage firm in order to carry out trades. When trading on margin, investors first deposit cash that serves as collateral for the loan and then pay ongoing interest payments on the money they borrow. This loan increases the buying power of investors, allowing them to buy a larger quantity of securities. The securities purchased automatically serve as collateral for the margin loan.

## What Is a Margin Call?

A margin call is a scenario in which a broker who had previously extended a margin loan to an investor sends a notice to that investor asking them to [increase the amount of collateral in their margin account](https://www.investopedia.com/ask/answers/052115/what-are-different-types-margin-calls.asp). When faced with a margin call, investors often need to deposit additional cash into their account, sometimes by selling other securities. If the investor refuses to do so, the broker has the right to forcefully sell the investor’s positions in order to raise the necessary funds. Many investors fear margin calls because they can force investors to sell positions at unfavorable prices.

## What Are Some Other Meanings of the Term Margin?

Outside of margin lending, the term margin also has other uses in finance. For example, it is used as a catch-all term to refer to various profit margins, such as the gross profit margin, pre-tax profit margin, and net profit margin. The term is also sometimes used to refer to interest rates or risk premiums.

## What Are the Risks of Trading on Margin?

When investing on margin, the investor is at risk of losing more money than what they deposited into the margin account. This may occur when the value of the securities held declines, requiring the investor to either provide additional funds or incur a forced sale of the securities.

## The Bottom Line

Investors looking to amplify gain and loss potential on trades may consider trading on margin. Margin trading is the practice of borrowing money, depositing cash to serve as collateral, and entering into trades using borrowed funds. Through the use of debt and leverage, margin may result in higher profits than what could have been invested should the investor have only used their personal money. On the other hand, should security values decline, an investor may be faced owing more money than what they offered as collateral.

> **Article Sources**
>
> 1.  U.S. Securities and Exchange Commission. "[Investor Bulletin: Understanding Margin Accounts](https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_marginaccount)."
>     
> 2.  Financial Industry Regulatory Authority. "[4210, Margin Requirements](https://www.finra.org/rules-guidance/rulebooks/finra-rules/4210)."
>     
> 3.  Federal Reserve Board. "[Compliance Guide to Small Entities Regulation U: Credit by Banks or Persons other than Brokers or Dealers for the Purpose of Purchasing or Carrying Margin Stocks](https://www.federalreserve.gov/supervisionreg/regucg.htm)."
>     
> 4.  U.S. Department of Housing and Urban Development. "[Adjustable Rate Mortgages (ARM)](https://www.hud.gov/program_offices/housing/sfh/ins/203armt)."
>     
> 5.  Consumer Financial Protection Bureau. "[For an Adjustable-Rate Mortgage (ARM), What are the Index and Margin, and How Do They Work?](https://www.consumerfinance.gov/ask-cfpb/for-an-adjustable-rate-mortgage-arm-what-are-the-index-and-margin-and-how-do-they-work-en-1949/)"