Buying on margin means you are buying your shares with borrowed money.
If you buy shares outright, you pay $ 5,000 for 100 shares of a share that costs $ 50 per share. Are yours. You paid them free and clearly.
But when you buy on margin, you are borrowing the money to buy stocks. For example, you don’t have $ 5,000 for those 100 shares. A brokerage firm could loan you up to 50% of what you would buy in stocks. All you need is $ 2,500 to buy all 100 shares.
Most brokerage firms set a minimum amount of capital at $ 2,000. This means that you must invest at least $ 2,000 to buy stocks.
In exchange for the loan, you pay interest. The broker is making money on her loan. They will also keep your shares as collateral against the loan. In case of default, they will take the stock. They have very little risk in the deal.
One way to think about buying on margin is that it is often comparable to buying a home with a mortgage. You apply for the loan in the hope that the value will increase and you can win. You have double the shares. All you need to see is that the additional profit exceeds the interest you paid to the broker.
However, there are risks when buying stocks on margin. Your share price could always go down. By law, the brokerage cannot allow the value of the collateral (the price of your title) to fall below a certain percentage of the value of the loan. If the stock falls below this set amount, the brokerage will issue a margin call on the stock from it.
The margin call means that you will have to pay the brokerage the amount of money necessary to bring the risk of the brokerage firms to the allowed level. If you don’t have the money, your shares will be sold to pay off the loan. If there is money left, we will send it to you. In most cases, little of your original investment remains after the sale of the shares.
Buying on margin could mean a great return. But there is a risk that you will lose your original investment. As with any stock purchase, there are risks involved, but when you use borrowed money, the risk increases.
Buying on margin is usually not a good idea for the beginner or a regular day trader. It’s something sophisticated investors have trouble with. The risk can be high. Make sure you understand all the possible scenarios that could happen, good and bad.