
To increase investment returns, many people try out margin trading, also called margin investment. It involves leveraging other people’s money, i.e., you are necessarily not investing directly with your money.
Like any typical investment, the investment may take a sour turn. Our team of security lawyers has years of experience representing investors in disputes with their broker-dealers concerning margin balances and auto liquidations.
Call us today at (202)444-4222 for a free and confidential consultation.
Margin trading is simply borrowing money to buy stock. It allows you to expand your investment beyond your resources. To buy on margin, your broker will create, for you, a margin account.
A margin account allows a broker to lend an investor cash to purchase stocks or other financial products. The balance in your account secures the loan.
Buying stock with borrowed money is called purchasing on “leverage.”
Margin loan usually comes with an interest rate lower than typical loans like credit cards.
The list of investments that are marginable varies from one brokerage firm to another, but generally, they are often stocks that trade for over $5 per share.
Many brokerages offering margin loans will allow you to borrow up to 50 percent of your asset’s value. The interest rate for loans less than $25,000 is about 8%, while higher amounts enjoy lower interest rates.
The interest is why brokerages are willing to charge little or no commission on margin loans.
To calculate the cost of borrowing, multiply the loan by the interest rate, then divide the result y the number of days in the year. The brokerage industry considers the number of days in the year to be 360 instead of 365.
Next, multiply the result by the number of days you expect to borrow to get the cost of the loan.
For example, if you borrow $20,000 at an interest rate of 8% for 20 days, below is how you calculate:
Using this example, it will cost you $88.89 in margin interest to borrow $20,000 for 20 days.
The Financial Industry Regulatory Authority (FINRA) mandates brokerage firms to demand a minimum margin of at least $2,000 or 100% of the purchase price. You must deposit this minimum amount in your account before being considered for a margin loan. The percentage of the trade value covered with your own cash is referred to as the initial margin.
The Federal Reserve Board Regulation T allows firms to lend investors up to 50% of the purchase price of securities. For example, if an investor wants to buy $20,000 in shares of a stock, the brokerage firm can lend no more than $10,000 while the investor covers the remaining $10,000 with an initial margin.
The maintenance margin is the percentage of an investor’s fund that must be maintained in the margin accounts. It is typically 25%, but some brokers set a higher limit. It helps to reduce investors’ overall debt.
Since stocks can go either way — rise or fall — any fall in the price will reduce your equity and may trigger a margin call.
A margin call is a situation whereby the equity in a margin account is too low to meet the maintenance margin requirement. In such an event, the broker will request the investor to deposit the deficit.
Evaluating the risk and profit potential of margin trading is vital to decide if it is a worthy investment.
Margin trading offers more buying power without scrambling for money or selling other securities to raise cash.
The leverage gives you the opportunity for higher profit potential. It often has more flexibility than other types of loans, as there may not be a fixed repayment schedule.
Just as it offers the potential to make a profit, margin trading can also result in losses. When the value of securities purchased using margin loans decrease, investors risk owing the broker an equivalent amount of the leverage in addition to the interest.
Yes, because brokers are not allowed to manipulate investors into making investments.
If you have lost money due to margin trading, our team of experienced investment fraud lawyers is available to discuss possible legal actions to take against your broker.
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