Brokerage firms can open an account for their trading customers to buy or sell on margin. This means the firm will allow the customer to borrow against the firm's assets or collateral to leverage stock or bond trades.
Margin Account - How to Buy or Sell On Margin
Accounts can be long or short. Long margin accounts allow investors to borrow up to 50% to buy securities. New margin account customers on a first trade, may be required to deposit more. Once the account is established, the investor must maintain a minimum level of equity value. Should that level fall below the requirement, the investor will get a margin call on the account. They cannot buy or sell stock during this period, until they deposit cash or fully paid securities to meet the payment needed.
Short selling must be done on margin. The stock is not owned by the customer when it is sold short, thus the broker or brokerage firm must provide that leverage. A cash deposit would be required before trading can begin. Minimum equity levels must be kept in the short account as well.
Most broker dealer investors like to have the margin account option available to them. This way, certain trading can be done above their current cash account position without having to open another account.
Long Margin Example
A customer buy 100 shares of ASD at $80 and wishes to do this trade in his margin account. The requirement would be a 50% deposit from the customer. Since this trade is valued at $8000 long market value, the deposit required is $4000.
The account breakdown would be as follows:
Long Market Value: $8,000
Debit Balance: $4,000
With the stock value at $8,000, the investor has $4,000 in equity. Should the stock vlaue rise in the long margin account, the equity would rise and the debit balance would remain the same. If the market value of the stock declines in the margin account, the equity would decline as well.
Brokerage firms will have a minimum equity requirement that must be maintained. 25% is the NYSE minimum, but most brokerage require higher percentages on their margin account customers.
There are a few major advantages to having a margin account over a regular cash market account. One is the ability to borrow money and have leverage from your broker dealer to purchase more stock than you would normally afford with just your cash alonw.
This ability to be able to gain more in cash profits comes with the added responsibility to cover larger losses, since you are borrowing more money that needs to be paid back - with interest.
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