What Does Margin Mean?
In finance, the margin is the collateral that an investor has to leave with their broker or exchange to cover the credit risk that the holder creates for the broker or exchange.
Credit risk is created when an investor borrows money from their broker to buy financial instruments, borrows financial instruments to sell them short, or enters into a derivative deal.
When an investor gets an asset by borrowing the rest of the money from a broker, this is called “buying on margin.”
When an asset is bought on margin, the first payment is made to the broker. The investor uses the marginable stocks in his or her brokerage account as collateral.
In business, the margin is the difference between how much a product or service sells for and how much it costs to make. It is also the measure of profit to sales.
Margin can also mean the part of the interest rate added to the index rate on an adjustable-rate mortgage (ARM).
KEY POINTS
- Margin is the money you borrow from a broker to buy an investment. It is the difference between how much an investment is worth and how much you borrowed to buy it.
- Margin trading is the act of trading a financial asset with money borrowed from a broker. The asset is used as collateral for the loan from the broker.
- A margin account is a standard brokerage account that lets an investor use the cash or assets in the account as collateral for a loan.
- When margin gives you leverage, it tends to make both gains and loses bigger. In case of a loss, a margin call could force your broker to sell assets without your permission.
How to Understand Margin and Trading on Margin
Margin is the amount of money that a trader has in his or her brokerage account. “To buy on margin” means to buy shares with money borrowed from a broker.
To do this, you need a margin account instead of a regular bank account.
A margin account is a brokerage account in which the investor borrows money from the broker to buy more stocks than they could buy with the money in their account alone.
Using margin to buy securities is a lot like getting a loan and using the cash or stocks you already have in your account as collateral.
The collateralized loan has a rate of interest that must be paid every month. Since the investor is using borrowed money, both the wins and losses will be bigger than they would be otherwise.
When the investor thinks that the return on the investment will be better than the interest they are paying on the loan, margin investing can be a good idea.
For example, if the starting margin requirement for your margin account is 60% and you want to buy $10,000 worth of securities, your margin would be $6,000 and you could borrow the rest from your broker.
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How Everything Works
When you buy on margin, you borrow money from a broker to buy stock. It’s like getting a loan from your bank. When you trade on margin, you can buy more stock than you would usually be able to.
You need a margin account to buy on margin. This is different from a regular cash account, where the money in the account is used to trade.
With a margin account, you put money into it, which is used as security for a loan to buy stocks.
You can borrow up to 50% of the cost of an investment this way. So if you put in $5,000, you could buy up to $10,000 worth of stocks.
This loan you’re taking out will cost you interest, which you’ll have to pay back. If you sell your stocks, the money will first pay off your loan, and then you can keep what’s left.
The Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) have strict rules about how much you must pay, how much you can borrow, and how much you must keep in your account.
Stay glued to this space for part 2 of this article.
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