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Using margin in the stock market can be a very powerful tool and can effectively double the amount of cash the trader or investor has to invest. Margin is the down payment required to make on the purchase of securities. The minimum amount of margin required for stock purchases is established by the Federal Reserve Board and for many years it has been 50 percent. In other words, an investor may purchase $30,000 worth of stock for a $15,000 down payment.

Your broker can help you establish a margin account with a minimum deposit, which, again, is established by the Federal Reserve Board. Some restrictions apply on the kind of stocks that may be purchased. For example, stocks selling for under $5 a share are not margined at most brokerage firms, and some over-the-counter shares may not be purchased on margin. The brokerage house will charge you interest on the loan.

The mechanics of buying on margin are pretty straightforward. Suppose you want to buy stock in XYZ Corporation, which is selling for $60 a share. If you have $6,000 to invest, you can purchase 100 shares outright, with no interest requirement. On the other hand, the same $6,000 will buy 200 shares on margin. If the price of the stock rises to $70 a share, your profit on 100 shares would be $1,000; on 200 shares you would make $2,000, less interest on the loan.

Rates vary, but are usually scaled up from the broker call loan rate, which is the rate banks charge brokerages, usually close to the prime rate. For loans under $10,000, you might have to pay 2 .25 points above the broker call loan rate. The rate is typically less for larger borrowings. Usually, monthly interest is added on to what you owe. The loan is repaid automatically when you sell the stock.

Just as you multiply your profit potential with margin, you also multiply the risk. If the price of your stock declines, the impact on a margin account will be more severe than it would be if you owned the stock outright. Suppose your $60 XYZ stock declines in price to $50 a share. If you own the stock outright, you can either sell the shares, limiting your loss to $10 a share or you can hold on to them hoping that the price will recover and allow you to recoup.

On the other hand, if you bought the stock on margin and the price declines, the broker will require you to put up additional cash to cover the loss in value. In this case, a $10 per share decline in price will result in a $2,000 reduction in the value of your account. If your equity in the account falls below the margin requirement, the broker will issue a margin call, which is a demand that you put up additional cash to bring your balance back to the minimum requirement.

Buying on margin increases the speculative risks of participating in the stock market. Seriously consider whether the risks are worth the potential reward before committing yourself to a margin purchase. Before you buy on margin, make sure you have sufficient funds to cover a margin call if the market declines. Also, determine how much profit you expect from the investment and if the potential profit is large enough to cover the interest and other transactions costs after taxes.


Jeff Neal 
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
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Listen to Jeff at www.ProfitStrategiesRadio.com

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