When you open a margin account, you borrow money from your broker to purchase securities. The key difference between a margin account and a regular cash account is that you can buy more shares of stock than you could with just the cash in your account with a margin account. For example, if you have $2000 in a cash account, you can buy up to $2000 worth of stock. However, with a margin account, you could be approved for an initial loan of $4000 and purchase $4000 worth of stock (if your broker allows it).
When your stocks go down in value, the broker will issue a “margin call,” which means you must deposit more cash or sell some of your holdings to bring the account up to the minimum requirement. If you fail to do that, then the broker will sell off your securities without contacting you (in most cases).
What is A Margin Account?
A margin account is a brokerage account that allows you to borrow money from your broker to purchase securities. On the other hand, a regular cash account only allows you to buy as much stock as you have in cash.
The margin interest rate is usually higher than a cash loan from a bank because it is riskier for brokers. Also, they must protect themselves from loss if their customers can’t repay the loan.
How a Margin Account Works?
A margin account works somewhat differently than a regular cash account. In a market downturn, the investor will have to pay back money borrowed from their broker called “margin”. If this does not happen, brokers can sell off securities without contacting investors.
To sum up, here are three key points to remember about margin accounts:
- You can buy more shares of stock with a margin account
- You are borrowing money from your broker to buy securities
- A downturn in the market means you have to pay back what was borrowed, or else brokers can sell off holdings without contacting investors
Margin Accounts Vs Cash Account
A direct comparison of margin account vs cash account depicts that margin account holders can purchase more stocks than cash-only buyers. Apart from this fundamental difference, margin accounts are also subject to interests and risks compared to a safe cash loan.
In case of non-payment or inability to repay debt, brokers have the right to sell securities without any prior notice to the investor, which is not usually the case with regular cash accounts.
On the other hand, cash account holders can only purchase stocks with the cash they have and no borrowing is allowed. In case of a market downturn and stock prices go south, these investors will not be required to pay back any money to their brokers as margin calls are not applicable on regular cash accounts.
The experts at SoFi Invest explain it in the best way:
“The accounts can be equated to a debit card vs. a credit card. A debit card requires the user to have funds available in their account to pay for anything they buy, while a credit card allows a user to spend and pay back the expense later.”
So, is margin trading a good idea? It depends on your circumstances and the risk tolerance level. If you’re comfortable with the risks and understand how margin accounts work, then it can be a great way to boost your portfolio’s returns. However, if you’re not comfortable taking on more risk, you should avoid margin trading.