Purchasing on margin means you are purchasing your stocks with borrowed cash.
If you’re purchasing stocks outright, you pay $5,000 for 100 shares of a stock that costs $50 a share. They’re yours. You’ve paid for them free and clear.
But when you purchase on margin, you are borrowing the cash to get the stock. As an example, you do not have $5,000 for those a hundred shares. A brokerage firm could loan you up to half of that in order to get the stock. All that you need is $2,500 to buy the hundred shares of stock.
Most brokerage firms set a minimum amount of equity at $2,000. This means that you have to put in at least $2,000 for the purchase of stocks.
For the loan, you pay interest. The brokerage is making profits on your loan. They may also hold your stock as the collateral against the loan. If you miss payments, they are going to take the stock. They have little risk in the deal.
One way to think of buying on margin is that it is often comparable to buying a home with a mortgage. You are taking out the loan in the hopes that the value will go up and you will make money. You are in control of twice the amount of shares. All you have to see is the additional profit exceed the interest you have paid the brokerage.
However, there are risks to buying stock on margin. The price of your stock could always go down. By law, the brokerage will not be allowed to let the value of the collateral (the price of your stock) go down below a certain percentage of the loan value. If the stock drops below that set amount, the brokerage will issue a margin call on your stock.
The margin call implies you’re going to have to pay the brokerage the sum of money critical to bring the brokers risk down to the authorized level. If you do not have the money, your stock will be sold to clear the loan. If there’s any cash left, you’ll be sent it. Usually, there’s not much of your original investment remaining after the stock is sold.
Purchasing on margin could mean a massive return. But there’s the risk that you might lose your original investment. As with any stock purchase there are hazards, but when you’re using borrowed money, the danger is increased.
Purchasing on margin is generally not a brilliant idea for the newbie or normal, each day financier. It is something that complex stockholders have issues with. The chance can be high. Make certain that you understand all the possible eventualities that might occur, good and bad.
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