Chapter 14 – Buying Stocks on Margin

You might want to make a trade, but you might not actually have the money to execute it. This is fine as many brokers will allow you to buy stocks on margin. Buying on margin is a simple concept. You borrow money from a broker to pay for a trade you wish to complete. You will use that money to buy more shares of a stock. You might also use the money to access a very expensive stock that you might not normally be able to afford. Margin trading is a risky strategy and it is so risky that some investment brokers might not allow you to make a margin account unless you have a history with that broker. To fully understand how margin trading works requires that you follow a few specific rules.

To start, you will need to apply for a margin account. A margin account is different from a cash account.
You must also sign a margin agreement and agree to the terms that a broker establishes for margin trading. This should include information on how large a margin trade can be and what the rate of the trade is.
You can make a trade. For instance, you might have $20,000 in a margin account. Perhaps you see a stock worth $400 per share. You might ask to buy 100 shares of that stock. However, that would require $40,000.
After you make the trade, the amount of money in your account will go toward part of the cost while the rest is a loan from the broker.
You will have to pay back the total value of that loan at some point. This will include interest at the margin rate. This makes it all the more important to look at the performance of that stock. You can always sell the stock at the appropriate time and cover the cost of the loan and the interest. This only works when you enter a position that succeeds.
You will also need to your margin totals. Your margin account might have certain limits as to what you can borrow at a time.

Margin Rates

The margin rate is the interest charged on a loan from a broker. Going back to the previous example, you might have been given a 7% rate on a margin of $20,000. This means you will have to pay $1,400 in interest on the margin trade. The rate is determined by the broker you use. For instance, Charles Schwab has a margin rate of 8.575% for people who deposit less than $25,000 into their margin accounts. That number is reduced to 7.075% for accounts of $100,000 and then reduced to 6.825% for accounts of $250,000 or more. Merrill Edge charges 9.625% for accounts of $25,000 or less and 7.125% for $100,000.

The good news about trading with a margin is that you can usually borrow up to 50 percent of the total value of the position you want to enter. This is the typical maximum. New margin traders should be able to borrow about 25 percent of their portfolio total. A new trader with a $20,000 budget could buy about $5,000 in trades handled on margin. This limit is often used because a person might not have enough experience with margin trading. The broker offering this deal is simply keeping the risk under control. With more buying power, it becomes easier to do more. As you have more money in your account and you continue to be profitable with margin trades, you may be given a higher total margin to work with. This can get you up to that 50 percent value that you are aiming for. For instance, you might be trying to purchase $10,000 in stock. You might have $5,000 that you will want to use in cash to pay for that investment. The other amount could be a margin offer.

A margin trading firm might have limits as to how much money you can spend on the trade. To trade $10,000 on a margin trade, for example, you might be required to have $15,000 or more in an account. Such rules are applied by trading firms to ensure that the people have the funds needed for executing trades and for repaying the loan and any charges associated with the margin if the trade goes south.