Margin Trading

DEFINITION Practice of buying stock with money borrowed from the broker. In this arrangement, the investor makes a cash down payment (called the margin) with the broker and can purchase stocks worth about twice the cash amount. The broker charges interest on this loan (in addition to the commission on each buy/sell trade) and the investor has to keep the entire stockholding with the broker as collateral. Also, the investor has to put up additional cash in case the value of the stockholding falls below a certain amount. Margin trading is a double-edged sword - it cuts both ways. If the stock price rises, the investor makes twice as much profit as with his own cash only. Similarly, if the stock price falls, the investor loses twice the amount. In slang, this practice is called 'investing on steroids.'

The investor must deposit an initial amount of cash or securities (initial margin or margin requirement) into a margin account with the broker, and must thereafter maintain a minimum amount of cash or securities (margin) in the account as collateral (maintenance margin, minimum maintenance or maintenance requirement). If the balance of a margin account falls below the minimum maintenance amount, the broker makes a margin call to the investor for the funds needed. Margin balances can be adjusted to reflect market values by adding or subtracting variation margins. Buying on margin gives the investor leverage as any capital appreciation or dividend income is on the total amount purchased. Even after the amount borrowed has been repaid to the broker, with interest, the investor could still be better off than if he/she had personally financed the purchase of a smaller amount of shares. That depends on how much the shares gain and how much they yield. Margin trading also carries some risk - if the shares fall in value, the investor suffers a capital loss while also facing potential margin calls from the broker.

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