Trading on margin means borrowing money from a brokerage to make an investment. It allows you to buy more stock by using your current investments as collateral against the funds borrowed from your brokerage. The amount of collateral that you are required to have is called the margin requirement.
By using borrowed funds, investors have the opportunity to leverage their gains. This means that when the stock goes up, the investor’s return is better than the stock’s increase. While this sounds like a great deal, investing on margin also comes with significant risks. When a margin investment goes against you, you will risk not only losing your initial investment, but also the funds borrowed on margin. If your stock prices drop so far that your collateral no longer covers your borrowed money, you will need to find more money to use as collateral.
In order to be eligible to trade on margin, an investor must establish a margin account with their broker. Most brokerages require an initial investment of at least $2000. This is known as the minimum margin.
After setting up a margin account, an investor can buy stock by paying cash in full or purchase a stock using margin, where the brokerage will pay up to 50 percent of the purchase price. The amount of your own cash used to pay for the stock is known as the initial margin.
Since buying on margin is the same as borrowing, the amount of margin used to purchase stock is subject to interest payments, just like any other form of borrowing. Also, strict requirements need to be satisfied to maintain a margin account.