Margin Call: What They Are, How They’re Triggered & How to Avoid Them
Cash accounts are the default type of accounts at brokerage firms. They require that all purchases of securities be fully paid for with cash and that the cash is in the account prior to purchase. With a margin account, you invest with money borrowed from your broker.
An investor with $5,000 in a cash account can only buy up to $5,000 worth of stocks, but in a margin account, they could buy up to $10,000 worth of stock with only $5,000 in cash.
Should the price of the stock purchased with cash rise to $7,500, you'll earn a 50 percent return on your investment. But if you bought the stock on margin – paying $2,500 in cash and borrowing $2,500 from your broker – you'll earn 100 percent return on the money you invested.
Margin increases your purchasing power, but also exposes you to the potential for larger losses. If the stock you bought for $5,000 in a cash account falls to $1,500, you would lose 70 percent of your money. However, if you bought on margin, you would lose more than 100 percent of your money.
Investors are charged interest on the borrowed money at prevailing interest rates, similar to a loan balance. There are, however, no loan payments required unless the value of the securities falls below the maintenance margin. Investors must maintain at least 25% equity in all existing positions.
When you get a margin call, your broker can demand you pay or sell out positions you currently own in order to satisfy the call and raise it so that the value of the investor's equity (and the account value) rises to a minimum value indicated by the maintenance requirement. Normally, the broker will allow from two to five days to meet the call. If you can't cover the call, your broker will liquidate your positions to get it covered.
Before opening a margin account, you should fully understand that:
- You can lose more money than you have invested;
- You may have to deposit additional cash or securities in your account on short notice to cover market losses;
- You may be forced to sell some or all of your securities when falling stock prices reduce the value of your securities;
- Your brokerage firm may sell some or all of your securities without consulting you to pay off your margin loan;
- You are not entitled to choose which securities your brokerage firm sells in your accounts to cover your margin loan;
- Your brokerage firm can increase its margin requirements at any time and is not required to provide you with advance notice; and
- You are not entitled to an extension of time on a margin call.
Before trading on margin, FINRA requires you to deposit with your brokerage firm a minimum of $2,000 or 100 percent of the purchase price of the margin securities, whichever is less. This is known as the “minimum margin.” Some firms may require you to deposit more than $2,000.
In summary, cash and margin accounts are both used to purchase and hold securities. The main difference is that margin accounts allow the account holder to borrow money from the broker using the securities in the account as collateral, while cash accounts only allow you to use your own money.
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