A margin account allows you to borrow against the securities you already hold in your brokerage account. You may wonder “Why would I want to do that?”
The answer is, for the same reason that you might buy anything on credit; because it gives you more flexibility.
You can think of it along the lines of a home equity loan – in a margin loan there is collateral and there is interest – but instead of the bank loaning you money against your house, your broker is loaning you money against your investments.
Usually, you can borrow up to 50% of the value of the securities you already own at the time the loan is generated. But unlike a home equity loan, there is generally no set repayment schedule for a margin loan, as long as you maintain the required minimum level of equity.
A margin loan can also be used as a source of credit for personal financing needs. In these cases, a margin loan can be a convenient and flexible way to borrow.
By far, the most common use of a margin loan is to purchase additional securities.
When using a margin loan, you can typically buy a new security, even if you don’t have enough cash to pay for it in full. Trading on margin may prevent you from having to sell any of your current positions, which could impact your trading strategy or trigger capital gains obligations.
It is important to keep in mind that while margin trading can magnify gains, it can also magnify losses. So you need to understand when and how it may make sense to use margin trading.
To learn more about how trading on margin works, check out the next video.
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