Candlestick Trading Blog

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Buying stocks on margin is a very high risk trading strategy that should be used only by very experienced investors. There are potentials for a very high profit, but of course with high risks for profit comes high risk for potential loss. Buying on margin is the borrowing of money from a stock broker to purchase stock.  Basically, it can be thought of as a loan from your broker. How it works is you have to open a margin account which typically requires that you set a minimum amount of equity at $2,000. This means that you have to put at least $2,000 in an account, and the broker loans this amount to you in the form of cash. This cash then must go towards the purchase of stocks. In return for the loan you have to pay interest. The loan in the account is collateral and if the value of the stock, or stock price drops sufficiently, the account holder is you are required to deposit more cash or sell a portion of the stock. Basically, when buying stocks on margin, you are investing your broker's money.

When investing in stock and buying on margin, keep in mind that you can keep you loan as long as you would like. That is as long as you fulfill your obligations. How it works is that after you first sell the stock in a margin account, the profit goes to your broker against the repayment of the loan until you have fully paid up. The deposit that you make into the account, when buying stocks on margin, is called the minimum margin and once this account is opened, you can borrow up to 50% of the purchase price of a stock. This portion of the purchase price that you deposit is known as the initial margin. Just because you can borrow up to 50% doesn't mean that you have to however. You can borrow 10% or 30%, depending on what you need to do when investing in the stock market.

Buying stock through a margin account with a brokerage firm requires that you also understand what a "maintenance call" or a "fed call" is. To understand these terms used in stock investing, you must first understand what a maintenance margin is. A maintenance margin is the minimum account balance that you must maintain before your broker will force you to deposit for funds into the account, or to sell stock to pay down your loan. If your margined securities fall below a certain level, then you, the borrower, receive a "margin call." This margin call, also known as a "maintenance call" or a "fed call" requires that the borrower sell off some assets or deposit more money since the margin account has fallen below this maintenance margin. Buying stocks on margin is risky because if the borrower cannot raise the cash, therefore forcing the broker to sell of some of their holdings, it can possibly result in short-term capital gains tax at very high rates.

Buying stocks on margin is very risky and is an investing strategy that only highly experienced investors should practice. Continue to learn about buying on margin to see if it works for you.