buying on margin

Buying Stock on margin basics

To buy on margin, you set up a margin account with a broker and transfer the required minimum in cash or securities to the account. Then you can borrow up to 50% of a stock's price and buy with the combined funds. This portion of the purchase price that you deposit is known as the initial margin.

To protect brokerage firms from losses, the New York Stock Exchange (NYSE) and the National Association of Securities Dealers (NASD) require you to maintain a margin account balance of at least 25% of the market price of any stock you buy long, to hold in your account. Individual firms can require a higher margin level, say 30%, but not a lower one.

If the market value of your equity falls below its required minimum, the firm issues a margin call. You must either meet the call by adding money to your account to bring it up to the required minimum, or sell the stock, pay back your broker in full and take the loss.

Buying on Margin Tips

Recognize the Risks. Margin accounts can be very risky and they are not suitable for everyone. Know that your firm charges you interest for borrowing money and how that will affect the total return on your investments. Be sure to ask your broker whether it makes sense for you to trade on margin in light of your financial resources, investment objectives, and tolerance for risk.

Know the Margin Rules. The Federal Reserve Board and many self-regulatory organizations (SROs), such as the NYSE and FINRA, have rules that govern margin trading. Brokerage firms can establish their own requirements as long as they are at least as restrictive as the Federal Reserve Board and SRO rules.