The risk is the engine of the stock market without which there would be no way to make money as your stock prices rise. However, the same risk that inflates stock prices one day can deflate them the next. For an average stock market investor, the ordinary risk of the market is enough to satisfy their financial goals without keeping them up at night. But for high-rolling investors who want to make large amounts of money quickly — and fully understand the serious risks involved — buying on margin is to be looked at.
However, buying on margin is deeply risky. You not only have the potential of losing your entire investment plus interest but losing, even more, money through something called a margin call. To have a margin account, the Federal Reserve Board requires that you always have enough money in your account to cover the maintenance margin. At a minimum, you must have enough cash (equity) in your margin account to equal 25 percent of the total price of the stock you own. If you don’t have enough cash in the account, your broker can issue a margin call requiring you to deposit enough money to reach the 25 percent maintenance level.
Margin call: Can you lose it all?
- If you open a margin account with your broker, you can buy twice as much stock as you actually have the cash to purchase. The limit for buying stock on margin is 50 percent—you need to pay for at least half of the stock you buy and you can purchase the other 5 percent on margin.
- You can’t invest any amount of money into a margin account. Federal regulations require a minimum investment of $2,000 in margin accounts, and most brokers require more
- While there are some similarities (paying interest, for example), credit debt is unsecured debt. There’s no collateral; stock bought on margin is secured by the stocks you paid for in cash.
- When a stock purchased on margin loses value, the loss comes out of your collateral stock first. The overall value of your stocks will be falling even as the dollar amount you owe to your broker for loaning you the stocks stays the same.
- Brokers can set any maintenance minimum they want, as long as it’s 25 percent or higher. If their analysis shows a stock is likely to lose value, they can set a maintenance minimum of 40, 50, even 75 percent – whatever they feel minimizes their financial risk.
- Your broker can “sell you out” at any time if you’re below the maintenance minimum. The father you get from the minimum, the more likely this is to occur.
- Margin stocks require some attention to minimize losses, generally on a day-to-day basis. You need to watch out for stock declines so you can sell before a margin call leads to financial disaster.
- If you margin stocks fall enough in value, you could actually end up owning your broker money. If the stock loses enough value, when your broker sells off the shares, the proceeds might not be enough to cover the cost of the loaned stocks. You’ll owe for whatever remains unpaid.
- The CEO of Chesapeake Energy in Oklahoma City suffered a massive loss when his stock, purchased on margin, fell in value.
- Buying on margin is a relatively advanced investment strategy not suited for stock market beginners. Investments always carry inherent risks, but investing on margin is even riskier.
- If a broker thinks a stock is too volatile, instead of requiring a high maintenance minimum, the broker may simply not offer that stock for purchase on margin at all.
- Margin calls are typically issued via a simple phone call or e-mail, or a notification in your account with the broker’s Website.
- You can’t control when your broker sells off your shares after a margin call. Your broker will sell your shares off in a way that minimizes their financial risk, not necessarily in a way that works to your advantage.
- If a stock bought on margin increases in value and you sell it, some portion of the profit will be used to repay the broker’s loan. The stock loaned to you by the broker will be paid for at the original value. Since you told them at the new, higher value, you can make a lot more money this way.
- You pay interest on the stocks loaned to you by the broker – and this can really add up. A stagnant stock is not a good candidate for buying on margin.
- The minimum amount of cash needed to buy a stock on margin, usually, 50 percent, is regulated by the Federal Reserve Board’s Regulation T.
- It’s very important to have cash reserves ready to meet margin calls. It doesn’t matter how confident you are in stock’s rise the market can be very unpredictable.
- Stocks that pay decent dividends are good candidates for margin investments because the dividends can make up the interest on the margin, increasing overall profit (as long as the stock rises in value).
- If you can’t make a margin call, your broker will sell off the stocks when they’re worth the least. You lose the option of holding them until they bounce back.