Margin Trading - Crazy Risks, Crazy Rewards By D. Alan Carter If you've ever taken out a loan, you've already received a glancing education in trading on margin. Margin trading, in it's simplest terms, is trading with borrowed capital. The lender in this case is your broker. You are, in effect, borrowing money from your broker to buy stocks. As with any cautious lender, there will be a demand for...  read more...

Margin Call - "Honey, The Phone's For You" By D. Alan Carter This is one phone call you're going to wish you didn't have to take. But take it you must. It means you've lost money on one or more stocks. So much money, that you've tripped the "maintenance margin" percentage and your broker is exercising his contractual rights to have you...  read more...

•  If stock prices fall, you may be forced to sell some or all of your securities at a time not of your choosing in order to satisfy margin collateral requirements. These forced liquidations can lead to substantial losses.
• Your broker may sell some or all of your securities, with or without notice to you, if it feels its loan is in jeopardy.

Margin Account - The First Step is a Margin Agreement

A 'margin agreement,' requiring your signature, defines the terms and conditions of the margin account. It will discuss the collateral for the loan (the securities you purchase and cash balances), detail your responsibilities for repaying the loan, and identify the methodology used for calculating margin interest on that loan and the actions the broker may take to safeguard its loan (for example, and most importantly, the broker will retain the right to sell your securities with or without notice to satisfy the loan and the equity requirements to which you've agreed).

Further, the margin agreement includes that you must abide by the rules of the Federal Reserve Board, the New York Stock Exchange, the National Association of Securities Dealers, Inc., and the brokerage firm where you have set up your margin account. If ever you should read an agreement carefully before signing, this is that agreement.

Margin Account - Learning The Rules of the Road

The Federal Reserve (the central banking authority in the United States), as well as numerous self-regulatory organizations (SROs), such as the New York Stock Exchange (NYSE) and the National Association of Securities Dealers, Inc. (NASD), have rules that govern margin trading. Brokerage firms can set in place their own rules so long as they are at least as restrictive as the Fed and SRO rules. Here are three of the key rules of the road you'll need to fully understand:

• Minimum Margin (Before You Can Trade On Margin). Before you can trade on margin, the NYSE (Rule 431) and NASD (Rule 2520) require that you deposit with your brokerage firm a minimum of $2,000 or 100 percent of the purchase price of the stock you have in mind, whichever is less. This is known as the "minimum margin." Some brokerage firms may require you to deposit more than $2,000, to which you will need to comply. Day traders are another story - if you plan to buy and sell the same stock on the same day, requirements dictate that you deposit and maintain $25,000 in your margin account.
• Initial Margin (The Amount You Can Borrow). According to the Federal Reserve Board (Regulation T), for new, or initial, purchases, you may borrow up to 50 percent of the purchase price of that stock. This is known as "initial margin." Keep in mind that any given brokerage firm may require you to contribute more than 50 percent of the purchase price, which is their prerogative. Also keep in mind that not all securities can be purchased on margin; to protect their interests, some brokerage firms may restrict or prohibit margin trading on individual stocks that are subject to particularly volatile price swings.
• Maintenance Margin (The Amount You Need To Maintain After The Trade). After the purchase of a stock on margin, you are required by the NYSE (Rule 431) and NASD (Rule 2520) to keep a minimum amount of equity in your margin account to protect the interest of the broker. The equity in your account is defined as the value of your securities less the amount you owe your broker. In general, the rules dictate that your equity in the margin account must not fall below 25% of the current market value of the securities in the account. The 25 percent is called the "maintenance margin requirement."

Fall below this maintenance margin, and at best you'll be issued a "margin call" and a short timetable to either deposit more funds or sell some or all of your securities. At worst, your broker may initiate--with or without notice--the sale of securities in that account to bring the account's equity back up to that maintenance margin requirement.

Keep in mind that a broker may have higher maintenance requirements than required by law, to which you will have to oblige. This is called a "house requirement," and may apply to your margin account in general, or to particular securities deemed a higher risk to the broker, and thereby  deserving a higher percentage of equity stake on your part. Indeed, some stocks will be so risky and volatile that you broker will prohibit margin trading at all.

 Margin Account - Tips and Advice

A word to the wise: some brokerage firms will initiate a margin account by default with new investors. When you open an account with a broker, make sure you understand if that new account is a cash account or a margin account. If you're the least bit uncomfortable with the concept of buying on margin, make sure you are set up with a cash account (in which there are no borrowing of funds from your broker, and purchases are therefore limited by the cash you have in the account).

Something else: your broker can change his "house requirement" at a moment's notice, or with no notice at all. That fact, plus the generally volatile nature of the stock market, dictates that you allow a sufficient cash cushion in your margin account at all times to account for the unexpected. One alternative, of course, is to cash out of your positions in all securities at the end of the day. But now we're talking day trading.

For more information: 
U.S. Securities and Exchange Commission - "Margin: Borrowing Money To Pay For Stocks" 
Wikipedia - "Margin (Finance)"

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