Understand the mechanics, math, rules, and risks of using borrowed money to trade securities.
Margin trading involves borrowing funds from your brokerage to purchase securities. Your existing cash and investments serve as collateral for the loan. Using margin allows you to buy more stock than you could with your cash alone, providing leverage.
Initial margin is the percentage of the purchase price that you must pay with your own cash. For example, if you buy $10,000 worth of stock with a 50% initial margin requirement, you provide $5,000 and the broker lends you $5,000.
Maintenance margin is the minimum equity percentage you must maintain in your account after buying on margin. If your equity falls below this level due to price drops, you will trigger a margin call.
A margin call happens when the value of the securities in your margin account drops, causing your account equity to fall below the maintenance margin requirement.
Established by the Federal Reserve Board, Reg T limits the amount of initial margin you can borrow to 50% of the purchase price of eligible securities. Brokerages can, and often do, have stricter requirements (e.g., higher initial margins or maintenance margins) than Reg T.
While standard margin accounts use Reg T rules based on fixed percentages, Portfolio Margin uses a risk-based model. It calculates margin requirements based on the maximum potential loss of your entire portfolio. For well-hedged portfolios, Portfolio Margin often results in lower margin requirements and higher leverage, but it requires higher account minimums and approval.
Margin amplifies both gains and losses. Let's assume you have $5,000 and borrow $5,000 on margin to buy $10,000 worth of stock.
If the stock price rises by 20%, your position is now worth $12,000. After repaying the $5,000 loan, you have $7,000 left. Your $5,000 investment grew by $2,000—a 40% return.
If the stock price drops by 20%, your position is worth $8,000. After deducting the $5,000 you owe the broker, your equity is $3,000. Your $5,000 investment lost $2,000—a 40% loss.
When you trade on margin, you are taking out a loan, which means you must pay interest. Margin interest rates vary widely by broker—ranging from over 13% at some traditional brokers to under 6% at specialized platforms. High margin rates can eat into your returns over time.
Margin is also required for short selling. When you short a stock, you borrow shares from the broker to sell them, hoping to buy them back lower. You must hold collateral in a margin account to cover the borrowed shares.
Who shouldn't use margin: Beginners, long-term investors buying volatile assets, and those who cannot afford to lose their principal.
Who might use margin: Experienced traders managing short-term trades, day traders needing buying power, or investors seeking temporary liquidity without selling assets.