Buying investments on margin, or margin investing, is a specific way you can trade securities — and it can offer DIY investors more flexibility. Before you dive into margin trading, it’s important to understand the details of this advanced investing technique.
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What is a margin account?
A margin account lets you borrow money to invest in securities traded on the stock market. Your brokerage decides details like:
Which securities can be traded on margin
The percentage of securities you must pay for with cash, known as the initial margin — you can legally borrow up to 50 percent of the purchase price, depending on your brokerage's policy
The amount of maintenance margin, or minimum equity, you need to have in your account (which typically depends on the value of your holdings, but varies by brokerage)
The interest rate on your margin loan
The maintenance margin, which is the minimum percent equity-to-account value required to hold positions on a margin before you get into a margin call
How does margin trading work?
Margin trading increases your purchasing power by allowing you to borrow from your brokerage rather than using only your own money. Essentially, you’re borrowing with the assumption that the price of the stock you’re purchasing will rise. A related strategy, short selling, works in the opposite direction — you borrow shares to sell them now, hoping to buy them back later at a lower price and pocket the difference. Both strategies have the potential to amplify your gains, but they can also increase your losses, even resulting in losing your initial investment and owing more on top of that.
To get started, you’ll first need to review and sign a margin agreement and set up a margin trading account with your brokerage. Then, once approved, make an initial transfer of at least $2,000 into your margin account. Once that’s done, you can double your buying power.
Trading on margin can amplify your gains, but it can also increase your losses.
Benefits of trading on margin
Potential advantages could include:
Increased buying power: By using borrowed funds, you can invest in larger positions with less capital.
Enhanced returns: Margin trading can magnify gains relative to initial investment.
Flexibility: You can use your margin account for personal expenses, with funds acting as a line of credit for quick trades or to retrieve cash without selling holdings.
Access to advanced trading strategies: Some options trades and short positions require margin.
Diversifying a concentrated portfolio: The additional capital allows you to buy different securities without liquidating core holdings.
Gains without margin
Event | Value |
|---|---|
Buy 50 shares of $100 stock | $5,000 invested |
Stock rises to $150 | +$2,500 (gain) |
Sell your 50 shares | $7,500 received |
Total gain | +$2,500 |
Gain with margin
Event | Value |
|---|---|
Buy 50 shares of $100 stock | $5,000 invested |
Invest in additional 50 shares on margin | $0 |
Total value of stock | $10,000 |
Stock rises to $150 | +$5,000 (gain) |
Sell your 100 shares | $15,000 received |
Repay margin loan (Note this does not include interest owed) | ($5,000) |
Total gain | +$5,000 |
Risks of trading on margin
Margin trading can also come with significant risks, including:
Magnified losses: Because you are using borrowed money, losses are larger relative to your initial investment.
Margin calls: If the value of your portfolio drops below a certain threshold, the broker can demand you deposit more cash or sell holdings.
Interest charges: Margin interest and other interest rates accrue daily, adding to the cost and reducing net returns.
Forced liquidation: If you fail to meet a margin call, brokers can sell positions without your consent to protect the brokerage.
Limitations on assets: Not all mutual funds or ETFs are eligible as collateral in all accounts. There are also other types of securities that are not eligible as collateral like options positions, securities during a certain number of days post-IPO, etc.
Theoretically unlimited losses: Unlike traditional investing — where your loss is limited to what you invested — strategies like short selling and certain advanced options positions carry theoretically unlimited downside risk.
Losses without margin
Event | Value |
|---|---|
Buy 50 shares of $100 stock | $5,000 invested |
Stock drops to $75 | $1,250 loss |
Sell your 50 shares | $3,750 received |
Total loss | $1,250 total loss |
Losses with margin
Event | Value |
|---|---|
Buy 50 shares of $100 stock | $5,000 invested |
Invest in additional 50 shares on margin | $0 |
Total value of stock | $10,000 |
Stock drops to $75 | $2,500 loss |
Sell your 100 shares | $7,500 received |
Repay margin loan (Note this does not include interest) | $5,000 repaid |
Total loss | $2,500 total loss |
Rules, disclosures and account limits
The SEC sets guidelines surrounding margin trading, but it’s important to closely review your margin agreement ahead of making any investments. In general, investors can typically borrow up to half of the total purchase price of marginable investments. If you’re an investor hoping to make the most of market volatility with margin trading, familiarize yourself with the rules before you make any moves.
What securities can be used as collateral?
Commonly accepted securities include:
Cash and cash equivalents
Equities
Fixed income
Mutual funds
Common margin trading strategies
Margin borrowing may be appealing to self-directed traders, but might be too risky for newer investors. You can’t eliminate risk entirely with margin trading, but if you’re considering the strategy, think about:
Leverage for growth trades: Use margin to increase your position in a high-conviction idea
Short selling: Borrow shares to profit from declines
Options strategies: Some spreads and advanced option trades require margin
Portfolio rebalancing without selling core assets: Retrieve cash via margin loan to rebalance
How to help manage margin risk
Following these guidelines can help you avoid costly margin calls and forced liquidations:
Set clear rules: As part of your trading strategy, define the maximum leverage and stop-loss levels you’re comfortable with.
Monitor margin level: Track equity-to-loan ratios and your maintenance margin cushion.
Keep cash reserves: Make sure to have available funds ready if you need to meet a margin call quickly.
Diversify holdings and reduce volatility exposure: Invest in less volatile securities when possible and avoid overconcentration in a single position or sector.
Ensure you review the full margin agreement: Understand how to retrieve funds or securities after a forced sale.
If you’ve weighed the positives and risks of trading on margin and consider yourself ready to invest, Ally Invest offers margin trading for self-directed investors.
Managing your margin
For experienced traders, a margin account can be a useful part of your investment strategy. By understanding the risks involved, you’ll be able to develop an informed trading plan aligned with your risk tolerance and financial goals.
