What is margin in trading?

Margin account vs. cash account

With a cash account, you trade only with your own settled money. With a margin account, your broker can lend you part of the money to buy and can also lend you shares to sell short. That loan charges interest while you use it and gives you leverage.

To trade on margin in the United States, FINRA requires a minimum of $2,000 in the account, and many brokers ask for more.

Initial and maintenance margin

• Initial margin: the part of the purchase you have to put up yourself. For US stocks, Regulation T sets a minimum of 50%.
• Maintenance margin: the minimum equity you must keep while the position is open, as a percentage of its value. FINRA’s minimum rule is 25% for long stock positions, and many brokers require 30% or more.

Futures work differently: there is no loan, and margin is a per-contract deposit set by the exchange and the broker. The figures vary by broker, country, and asset.

Example of a margin call

Example: you buy $20,000 of stock with $10,000 of your own and $10,000 borrowed. Your broker requires 25% maintenance.

Your equity is the value of the shares minus the loan. If the shares fall to $13,000, your equity drops to 13,000 − 10,000 = $3,000, which is 23% of the position’s value. That’s below 25%, so you get a margin call: to get back to 25% of $13,000 ($3,250), you have to deposit $250 or sell some of the shares.

Notice the proportion: the shares fell 35%, but your equity went from $10,000 to $3,000, a 70% drop.

In this example, the call would come as soon as the value of the shares fell below about $13,333: at that point, the equity ($3,333) is exactly 25% of the value.

The cost of using margin

Example: you borrow $10,000 at an annual rate of 9% and hold the position for 30 days. Using the 360-day year convention many brokers use, the interest is 10,000 × 0.09 × 30 / 360 = $75. If the trade makes $300 over that time, the interest takes a quarter of it; if it loses, the interest adds to the loss.

How to avoid surprises

• Know the maintenance requirement your broker sets for each asset; it can be higher for volatile stocks.
• Work out in advance the price at which you would get a margin call, as in the example above.
• Keep in mind that your broker can raise the maintenance requirement during periods of high volatility.
• Remember that your broker can close your positions on its own, without waiting for your response, if your equity falls too far.
• Use a stop loss to get out before your broker decides for you.