A margin account is a loan account provided by a broker which can be used for leverage trading. The funds available under a margin loan are determined by the broker based on the securities owned and provided by the trader, which act as collateral over the loan. The broker usually has the right to change the percentage of the value of each security it will allow towards further advances to the trader, and may consequently make a margin call if the balance available falls below the amount actually utilized. In any event, the broker will usually charge interest, and other fees, on the amount drawn on the margin account. Here are some examples of margin trading.
Buying long with a margin account:
- If we buy a share in a company for $100 using $20 of our own money and $80 borrowed from her broker. The net value (the share price minus the amount borrowed) is $20. The broker wants a minimum margin requirement of $10.
- Let's say the share price drops to $85. The net value is now only $5 (the previous net value of $20 minus the share's $15 drop in price), so, to maintain the broker's minimum margin, you will need to increase this net value to $10 or more, either by selling the share or repaying part of the loan.
Shorting with a margin account:
- If we sell a share in a company not owned for $100 and puts $20 of our own money as collateral, resulting $120 cash in the account. The net value (the cash amount minus the share price) is $20. The broker wants a minimum margin requirement of $10.
- Suppose the share price rises to $115. The net value is now only $5 (the previous net value of $20 minus the share's $15 rise in price), so, to maintain the broker's minimum margin, Jane needs to increase this net value to $10 or more, either by buying the share back or depositing additional cash.
Keep in mind that when utilizing a margin account, the broker retains the right and has the ability to liquidate your positions if they exceed the margin tolerance. This is called a margin call. For more information on margin calls, click here.