Trading stock and other investment securities on the margin is a credit system in which an investor accepts a loan from a broker or investment firm to complete securities purchases. Margin buying and selling is only for the experienced investor with a history of smart financial transactions, as the potential liability for trading in this manner can be great if stock prices suddenly drop.
Purchasing on Margin
An investor purchases on margin when he contributes a portion of the purchase price for a stock or other securities investment, with his securities broker paying the outstanding balance. The securities broker is willing to pay part of the purchase price based on the profit potential of the newly-acquired investment. The broker retains possession of the purchased investment as collateral to compel the investor to repay the broker's portion of the margin purchase. If the investor doesn't pay, the broker keeps the securities investment.
Broker Margin Calling
A margin call is a demand from a broker or futures clearing house to a client or member to contribute money to her margin deposit account to bring up the balance lost by a dip in investment value. An investor must usually bring the balance up to a predetermined minimum level to keep the account current and continue building a portfolio, according to BusinessDictionary.com. An investor failing to make the necessary deposit to bring the account current loses the ability to trade on margin with the broker, or futures clearing house, and may also lose possession of all margin stock in her portfolio.
Short Selling Stock
Short selling stock is a type of margin trading in which an investor sells a share of stock he does not own. A broker or investment firm loans the security to the investor at the time of the transaction so the investor can process the transaction. The investor's liability for the loan remains until he purchases sufficient stock to replace what the broker or investment firm previously loaned him. If the stock price drops before the investor buys stock to replace the loan, he turns a profit. If the stock price rises, he takes a loss.
Restrictions on Short Selling
As of 2004, the U.S. Securities and Exchange Commission (SEC) placed restrictions on short selling. According to Fidelity.com, the Short Sale Rule only allows the practice of short selling under market conditions where the stock price in question is on the rise or stable from its previous trading position. This helps prevent an investor from taking a significant financial loss due to a falling stock price. An investment firm or broker also retains the right to reject any short sale offer.
- BusinessDictionary.com: Margin Call
- Fidelity.com: Margin and Selling Short
- FINRA. "Margin Account Requirements." Accessed August 14, 2020.
- U.S. Securities and Exchange Commission. "NYSE Rulemaking: Notice of Filing of Proposed Rule Change To Amend NYSE Rule 431 (“Margin Requirements”)." Accessed August 14, 2020.
Jonathan Lister has been a writer and content marketer since 2003. His latest book publication, "Bullet, a Demos City Novel" is forthcoming from J Taylor Publishing in June 2014. He holds a Bachelor of Arts in English from Shippensburg University and a Master of Fine Arts in writing and poetics from Naropa University.