Stock margin is money you borrow from your broker to increase your buying power. When you borrow money to buy stock, cash in your brokerage account is held as collateral. Margin allows you to control significantly more stock shares than you have money to pay for, increasing your profit potential. Keep in mind, using margin also increases your risk.
How Margin Works
If you buy IBM stock for $100 and the price rises to $150, you would earn a 50 percent profit if you sell. Now assume you bought IBM on margin, paying only $50 from your account and borrowing $50 from your broker. If the price of IBM rises to $150, your profit from your $50 investment would be 100 percent. Of course, when you sell, you will need to return $50 plus interest to your broker.
When you increase your buying power using margin, you also increase your risk. It is possible to lose more money than you have in your trading account. Using the IBM example, if the price of the stock falls from $100 to $40, you would lose your entire $50 investment in addition to $10 of your broker's money, which you will be required to pay back.
Each broker has the right to establish its own margin rules, as long as they comply with rules established by the Financial Industry Regulatory Authority, an organization that regulates securities brokerages. FINRA requires you to deposit at least $2,000 into your account before it can be eligible for margin. In addition, margin accounts are restricted to a maximum of four times buying power, which means you must have cash to pay for at least 25 percent of the stock you buy.
If the market value of the stock you buy falls below the 25 percent margin maintenance amount, you will receive a margin call requiring you to sell your stock or add money to your account. For example, if you have $2,500 in your account, you could buy $10,000 worth of stock on margin. If the market value of your stock falls to $9,000, the equity in your account would fall to $1,500, requiring you to sell some or all of your stock or add at least $750 to your account.
Donald Harder has been writing financial-related articles since 2000 when he founded the firm Securities Research Services. He has worked as a speech writer for the U.S. Department of Justice and written white papers and studies for the U.S. Department of Housing and Urban Development. Harder holds a Master of Arts in international affairs from George Washington University.