What To Know About Margin Accounts
For investors, using a cash account vs a margin account can impact how they trade and what they can do with their funds. Investors can use margin accounts to take advantage of leverage, potentially increasing returns and gaining flexibility as well as for short selling, diversification, and hedging strategies. While margin accounts can offer opportunities, they come with the risk of amplified losses and require careful management. Read on to learn a margin account meaning and more.
What is the Margin Account
A margin account enables you to borrow funds from a brokerage to purchase securities. It is also the only account type that allows investors to engage in short selling and it requires investors to contribute part of the security's purchase price, while the brokerage lends you the remainder to enact transactions in your account.
Margin account requirements
When opening and maintaining a margin account, there are several key requirements imposed by both Financial Industry Regulatory Authority (FINRA) and individual brokerages. These rules help ensure that investors have sufficient capital to cover potential losses when borrowing money to buy securities on margin. The main requirements for margin accounts include the following:
Minimum initial deposit (Minimum Margin): Regulation T (Federal Reserve) requires an investor to deposit a minimum of 50% of the purchase price of securities when buying on margin. For example, if you want to buy $10,000 worth of stock on margin, you must contribute at least $5,000 from your own funds, while the brokerage lends you the remaining $5,000. Some brokerages may require more than the federal minimum, depending on the account size or the investor’s creditworthiness.
Maintenance margin: After buying securities, investors must meet maintenance margin requirements, which are the minimum amount of equity (value of your own funds in the account) that must be maintained at all times. FINRA requires a minimum maintenance margin of 25% of the total market value of the securities in the account; however, most brokerages set a higher requirement, typically between 30% to 40%.
Portfolio margin (PM): PM is a risk-based margining strategy that can help investors increase their available budget by aligning margin requirements with the overall risk of their portfolio. It can be applied in real time to eligible accounts that meet minimum initial equity requirements. PM uses a pricing model to calculate the largest theoretical loss across different stress test scenarios, helping to ensure that margin requirements more precisely reflect the actual net risk of the products in the portfolio.
How does a margin account work
The brokerage firm extends credit with the securities bought serving as collateral for the loan. But with this increased buying power, comes added risk. Brokerages determine the initial margin, the minimum percentage of the transaction that investors must cover with their own funds, and the maintenance margin, which is the minimum amount of equity an investor must maintain to avoid a margin call.
If the equity in the account falls below this threshold due to market fluctuations, investors may be required to deposit additional funds or sell some of their holdings to meet the margin requirement. While margin accounts offer the potential for greater returns, they also offer a risk of substantial losses if the value of investments declines significantly.
Margin interest rates
Margin interest rates are the interest rates that investors or traders pay on the money they borrow from a broker to buy investments or execute trades. Margin interest rates are calculated on loans between the investor and the broker for the assets in the investor's portfolio.
This calculation is multiplying the annualized interest rate by the amount borrowed and the time frame of the loan. The value of the assets an investor has with the broker affects the margin interest rate. The higher the value of the assets, the lower the margin interest rate.
Margin Call
A margin call is a demand from a brokerage firm to increase the amount of cash or securities in a margin account when it falls below a certain level. This level is known as the maintenance margin.
Margin calls can happen for different reasons, including:
Losing trades: When the value of investments purchased with borrowed money declines
Short selling: When a stock increases in price and losses mount in accounts that have sold the stock short
If a trader doesn't meet a margin call, the brokerage can sell assets without notice to cover the shortfall. This can include selling shares bought on margin or other assets in the account. The brokerage can also charge a commission for the transaction.
Keep in mind margin trading is considered to be more risky and is primarily for experienced investors.
Margin Accounts vs Cash Accounts
Cash accounts and margin accounts can be used by investors for different reasons but the main difference between the two is that a cash account limits your investments to the money you have in your account, while a margin account allows you to borrow money to buy securities.
When creating a new account with your broker, you can either create a cash account or a margin account.
With a cash account, you’ll only be able to purchase shares based on the total amount of cash in your account. This is not a bad thing depending on your risk profile.
With a margin account, you’ll be able to access additional funds that your broker can lend to you. For some traders, this is an advantage in increasing their potential returns but can have higher risk and trigger a margin call.
Benefits and Risks of Margin Account
A margin account offers both advantages and risks to investors, making it an attractive option for some while posing risks. Here's an overview of the key potential benefits and risks:
Potential benefits of Margin Accounts
Increased buying power: Margin accounts allow you to borrow money from your brokerage firm to buy securities, which increases your purchasing power.
Leverage assets: You can use the value of securities you already own to increase the size of your investment. This can potentially increase your returns if the value of your investment rises.
Potential risks of Margin Accounts
Amplified losses: Because of leverage, losses can exceed your initial investment. This can happen if the value of the securities you purchase declines.
Interest costs: You may have to pay interest on your margin account, and rising interest rates can increase your margin interest rate.
Market volatility: Market volatility and sudden price fluctuations can lead to significant losses.
No guarantees: There's no guarantee that your returns will exceed your margin borrowing
Setting Up Your Margin Account With moomoo
In conclusion, a margin account can be a great tool to help you achieve better returns with lower starting capital. However, investors and traders need to be aware of the risks associated with a margin account.
When you register for a moomoo account, you automatically create a margin account as long as the net assets of your account are more than $2,000 USD.
Should the value of assets in your account drop below $2,000 USD, margin services will not be available for your account.
This setting can be disabled by contacting our support team once your account is created. If you decide to change your investing or trading strategy, you can then contact our team to turn on your margin account once again.
At moomoo, our goal is to provide investors of all experience levels with an intuitive and powerful investing platform by using technology.
moomoo Margin Account Features
With a moomoo Margin account, here are some things you can do:
If you do not have sufficient funds to open a position, margin will be used.
If you think stock prices will be falling, you can short sell stocks.
Images provided are not current and any securities are shown for illustrative purposes only.
Trade previews allow you to estimate the effects an open position will have on your account margin. This helps you better plan your trades and manage your risk.
The moomoo margin account identifies which stocks are marginable and shortable, along with the margin and loan rates.
Images provided are not current and any securities are shown for illustrative purposes only.
On the risk account details page, we show your account risks, disposal suggestions and early warning information based on fluctuations of the individual stocks you hold.
Images provided are not current and any securities are shown for illustrative purposes only.
FAQs about margin accounts
Should a beginner use a margin account?
A beginner generally should not use a margin account. Trading on margin means borrowing money from a broker to invest, which can amplify both potential gains and losses. If the market moves against you, you could lose more than your initial investment. Costs can add up from margin calls and interest costs.
Margin accounts also require a deeper understanding of how markets work and the risks involved. And trading on margin can increase emotional pressure, which for beginners, can lead to impulsive decisions and poor risk management.
How do I open a margin account?
To open a margin account, an investor must have a brokerage account with a registered broker-dealer and a minimum balance of at least $2,000. Some brokerages may require more. The broker must obtain the investor's consent to open the account and the investor must complete and sign a margin agreement. This may also include a hypothecation agreement, credit agreement, and loan consent form.
Is margin money my money?
No, margin money is not solely an investor's money. While margin money allows investors to increase their buying power, there's two components: it consists of both the investor's funds, representing a stake in the securities purchased and the borrowed funds from the brokerage, which is lent by them. The investor is required to pay interest on this borrowed amount.
Can you lose money on margin?
Yes, investors can lose more money than they invest when trading on margin when they buy stocks on margin and the value of those stocks declines; they can lose more than the amount they initially invested.
There's also the potential for forced sales from when an investor's account equity falls below the maintenance margin requirements; the firm can sell their securities to cover the margin deficiency, which can happen without notice. And if an investor violates a margin call, they may incur additional fees and penalties, such as administrative fees and interest charges.
Can I withdraw from my margin account?
Yes, an investor can withdraw funds from a margin account, but there are specific conditions and considerations involved. Conditions include:
Available equity: You can only withdraw funds up to the amount of equity in your account after accounting for any borrowed funds. This means you must maintain the minimum margin requirements set by your brokerage.
Margin Requirements: If you withdraw too much and fall below the required margin level, you could face a margin call, where the brokerage requires you to deposit additional funds or sell securities to meet the maintenance margin.
Margin requirements are particularly important in day trading because of the high frequency of trades and the inherent risks involved. In the U.S., day trading margin requirements are regulated by FINRA under a rule known as the Pattern Day Trader (PDT) Rule. FINRA defines this as any trader who executes four or more day trades within five business days, provided the trades represent more than 6% of the total trades in their margin account during that period.
Read here for more FINRA guidelines.
Liquidation of Assets: A brokerage can sell securities in a margin account to cover an outstanding margin loan. This typically occurs when the equity in the account falls below the maintenance margin requirement, often following a significant decline in the value of the securities held in the account. The broker will sell enough of the investor's securities to bring the account back to the required margin level. This is done without the investor's consent.
Brokerage firms may also have their own specific policies and procedures, so investors will also need to check with them.
