source : investopedia.com
Why is purchasing stocks on margin considered more risky than traditional investing?
Buying on margin involves borrowing money from a broker to purchase stock. A margin account increases your purchasing power and allows you to use someone else’s money to increase financial leverage. Margin trading confers a higher profit potential than traditional trading but also greater risks. Purchasing stocks on margin amplifies the effects of losses. Additionally, the broker may issue a margin call, which requires you to liquidate your position in a stock or front more capital to keep your investment.
Suppose you have ,000 in your margin account, but you want to buy stock that costs more than that. The Federal Reserve has a 50% initial margin requirement, meaning you must front at least half the cash for a stock purchase. This requirement gives you the ability to purchase up to ,000 worth of stock, effectively doubling your purchasing power.
After you make the purchase, you own ,000 in stock and you owe your broker ,000. The value of the stock serves as collateral for the loan he has given you. If the stock price increases to ,000 and you sell it, you keep what remains after paying back your broker (plus interest). Your proceeds equal ,000 (minus interest charges) for a 100% gain on your initial investment of ,000. Had you initially paid for the entire ,000 yourself and sold at ,000, your gain is only 50%. This scenario illustrates how the leverage conferred by purchasing on margin amplifies gains.
Leverage amplifies losses in the same way. Suppose the stock price decreases to ,000 and you sell it to prevent further losses. After paying your broker the ,000 you owe him, your proceeds come to ,000. You lost half your original investment. With traditional investing, however, a price drop from ,000 to ,000 only represents a 25% loss.
Another risk of purchasing stocks on margin is the dreaded margin call. In addition to the 50% initial margin requirement, the Financial Industry Regulatory Authority (FINRA) requires a maintenance margin of 25%. You must have 25% equity in your margin stocks at all times. Your margin agreement with your broker may call for a higher maintenance margin than FINRA’s minimum. If the value of your stock decreases and causes your equity to fall below the level required by FINRA or your broker, you may receive a margin call, which requires you to increase equity by liquidating stock or contributing more cash to your account.
Returning to the example above, assume your broker’s maintenance margin requirement is 40%. Because you owe your broker ,000, a drop in the stock price from ,000 to ,000 decreases your equity to ,000. That is only 33% of the stock price – you have fallen below the 40% minimum. If you cannot or choose not to contribute more capital to cover the margin call, your broker is entitled to sell your stock, and he does not need your consent.
Why is purchasing stocks on margin considered more risky than… – Learn why purchasing stocks on margin is riskier than traditional investing, although it can be more profitable when it is executed properly. Buying on margin involves borrowing money from a broker to purchase stock. A margin account increases your purchasing power and allows you to use…If you have been investing for a while, you have undoubtedly considered buying stock on margin. And why not! Your broker offers margin investing (what As you can see, playing on margin can be risky should your stocks decline significantly. If you do use margin at some point, keep it conservative.The idea of a brokerage margin loan is that you can use margin to buy more stocks than you would normally. (Getty Images). Each broker that offers margin loans has its own terms. In general, though, brokers have a list of investments, usually stocks and bonds, that are considered "marginable."
Why Buying Stock on Margin is Not a Good Idea? – Value Stock Guide – What's Considered "Margin?" Similar to mortgages and other traditional loans, margin trading typically requires an application and posting collateral with Let's say you want to buy 1,000 shares of a stock that's currently trading at $50 per share. If you bought it with only the cash in your account, you'd…Taking advantage of these loans is called buying on margin. Purchasing stocks on margin means the investor borrows part of the purchase price of the stock. All securities purchased on margin must be maintained with the brokerage firm in street name, for the securities are collateral for the loan.Investing on margin is the same way. If you understand how it works, use it judiciously, and can manage your risk well, it can help you generate nicer returns. On the other hand, if you are not disciplined enough, or misuse it or get carried away chasing a hot stock, it can drain your account dry.
Should You Use Brokerage Margin Loans? | Investing 101 | US News – Buying stock on margin is similar to buying a house with a mortgage. If you buy a house at a purchase The additional stock you deposit can be stock that's transferred from another account. If you're a beginner, consider using margin to buy stock in large companies that have a relatively…Margin buying power refers to the amount available for investors to purchase securities. Although the initial margin requirement of ABC stock is 50%, the maintenance margin requirement of None of the information provided should be considered a recommendation or solicitation to invest in, or…3. Buy the amount from (2) on margin, and then spend the rest of your investing It can change anytime. This is why margin is not great for long term investing. Definitely know what you are investing in, specifically understand the max Maintenance margin for stocks/ETFs in a Reg T margin account is 25%.