Margin trading: how buying on margin works

Written by the Tactfolio research teamPublished 5 min read

Margin trading means buying investments with money you borrow from your broker. The shares you buy back the loan. In the US you can usually borrow up to half the price of a stock. You must also keep at least 25% of the account’s value as your own money. If falling prices push your share below that line, your broker issues a margin call and can sell your shares.

Key points#

  • A margin account is a brokerage account where the broker lends you cash and holds your investments as collateral.
  • Federal Reserve Regulation T lets you borrow up to 50% of the price of a stock when you buy.
  • FINRA rules say your own share of the account must stay at 25% or more. Many brokers ask for 30% to 40%.
  • Borrowing half the price doubles your gains and losses on your own money. You pay interest on the loan either way.
  • You can lose more money than you put in.

Risk note. Leverage makes losses bigger as well as gains. You can lose more than you put in.

How does buying on margin work?#

Buying on margin works like a loan backed by your shares. You put in part of the price. The broker lends the rest and charges interest.

Three rules set the limits:

RuleWhat it saysWho sets it
Minimum marginDeposit at least $2,000, or the full price if it is less, before you borrowFINRA
Initial marginBorrow up to 50% of the purchase priceFederal Reserve, Regulation T
Maintenance marginKeep your equity at 25% or more of the market valueFINRA Rule 4210

Your equity is what the shares are worth minus what you owe. Brokers can set stricter “house” rules. The SEC says many ask for 30% to 40% (Investor.gov).

Borrowing like this is a form of leverage. It lets you control more stock than your cash alone could buy. Margin is one of several ways traders borrow to trade bigger. Others, like CFDs, are not offered to everyday US investors.

What is a margin call?#

A margin call is your broker’s demand for more cash or shares when your equity falls below the maintenance level. If you do not pay, the broker sells your holdings.

FINRA lists three common triggers: prices fall, you trade past your buying power, or the broker raises its house rules (FINRA). The broker can raise its rules at any time without written notice. It can also sell your shares without asking you first, and you do not get to pick which ones.

A margin call, worked out with round numbers#

Say you have $10,000. You borrow $10,000 more and buy $20,000 of one stock. The maintenance level is 25%. To keep the math clean, we leave out interest.

Stock valueYou oweYour equityEquity as % of valueWhat happens
$24,000 (up 20%)$10,000$14,00058%You made 40% on your $10,000
$20,000 (no change)$10,000$10,00050%Starting point
$15,000 (down 25%)$10,000$5,00033%You lost half your money. No call yet
$13,333 (down 33%)$10,000$3,33325%At the line. One more dip triggers a call
$12,000 (down 40%)$10,000$2,00017%Margin call. You need $3,000 of equity, so you must add $1,000
$8,000 (down 60%)$10,000minus $2,000below zeroYou lost all $10,000 and still owe $2,000

Look at the 40% drop. The stock fell 40%, but you lost 80% of your own money. At a 40% house rule, the call would have come at about $16,667, after a drop of only about 17%.

The math for the call line is: value at call = loan ÷ (1 minus the maintenance rate). Here that is $10,000 ÷ 0.75, or about $13,333.

What does margin cost?#

Margin costs interest, and the interest is due whether your trade wins or loses. Rates differ a lot from broker to broker. Interest raises the return you need to break even.

Say you borrow $10,000 at 10% a year. That is $1,000 of interest in a year. Your $20,000 position must rise 5% before you are ahead at all.

Common mistakes#

  • Opening a margin account by accident. Some brokers make it the default type. Check before you sign.
  • Planning around 25%. Your broker’s house rule may be higher, and it can change.
  • Waiting for a phone call. A broker does not have to warn you before it sells.
  • Using margin on one stock. A single bad day can wipe out your equity.
  • Forgetting interest. A flat year on margin is a losing year.

Try it on Tactfolio#

Tactfolio does no margin borrowing. Its strategies hold only what your cash can buy, and each one trades only the starting balance you give it. To see how margin math works, try our free margin calculator. It is an education tool, not a trading feature. Some investors look at leveraged ETFs instead, which add leverage inside the fund rather than through a loan. These funds reset daily. Held for longer, their returns can differ a lot from the multiple in their name.

Common questions#

Can you lose more than you invest with margin?#

Yes. If the shares fall far enough, their value can drop below what you owe. You still owe the broker the full loan plus interest, even after your own money is gone.

How much can I borrow on margin?#

Under Regulation T, you can usually borrow up to 50% of the price of an eligible stock. You also need at least $2,000 in the account under FINRA rules. Your broker can set lower limits and may not allow margin on some stocks at all.

What happens if I cannot meet a margin call?#

Your broker will sell some or all of your holdings to bring the account back above its maintenance level. It can do this without telling you first, and it picks what to sell. If the sale does not cover the loan, you owe the rest.

Is margin trading the same as short selling?#

No. Buying on margin is borrowing cash to buy shares you think will rise. Short selling is borrowing shares to sell, hoping to buy them back cheaper. Short selling also needs a margin account.

Sources

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