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What Is Margin Trading?

Margin trading (buying on margin) involves getting a loan from your broker to buy stocks. While margin trading can amplify returns, it also carries enormous risks—including the possibility of your broker selling your securities if your stock tanks. 

Margin trading explained

When you trade on margin, you’re borrowing money from your broker to buy securities. As buying on margin is a form of leverage, it has the potential to magnify returns and losses alike. In other words, while leverage lets you buy more, you’re out your investments and the value of your loan if the assets tank. 

Margin loans

Margin loans are secured loans that use cash or other securities as collateral. They require you to open a margin account before your broker issues a loan to buy stocks. 

Unlike other kinds of loans, margin loans may not have a set repayment date. As long as you make interest payments and meet your trading requirements, your loan remains open. Then, when you sell your securities, the proceeds pay off your loan first. 

Margin trading requirements

Margin trading is strictly regulated by the SEC, Federal Reserve and FINRA, with individual brokers sometimes setting stricter limits. Basic limits include:

  • Marginable securities - The Federal Reserve Board doesn’t allow margining penny stocks, IPOs or OTCBB securities
  • Minimum margin - This is your minimum deposit, as the FINRA requires traders to deposit the lesser of $2,000 or 100% of a security’s purchase price upfront
  • Initial margin - This is how much of the initial purchase price you’re required to cover. Current rules allow you to borrow up to 50% of the initial price
  • Maintenance margin - This is the minimum equity needed to keep your margined position open. FINRA dictates that your equity must remain above 25% of the market value of the securities in your account

Meeting margin calls

If your margin account declines below maintenance levels—when assets decline—your broker will issue a margin call. This gives you a few hours or days to deposit more cash or securities. But if you can’t meet the margin call, your broker will sell your securities to bring your account in line. 

Risks of margin trading

Margin trading increases your buying power and flexibility—and your investment risks. 

For instance, because stock (and other investment) values fluctuate, you’re at risk of falling below maintenance levels. And if your broker initiates a margin call you can’t meet, you may lock in losses or have to pay capital gains taxes when they sell your stocks.  

But ultimately, one of the biggest risks is losing more than you would otherwise. If your stock’s value drops, you’ll lose both share value and the cost of your margin loan. 

What this means for you

Margin trading is a risky strategy that can amplify gains and losses. As such, it’s generally advised that beginning and long-term investors avoid margin trading. 

Fortunately, you don’t need margin trading to be a successful investor when you have Q.ai’s AI-backed investing app. Simply pick your preferred Investment Kits, fund your account and let us invest and rebalance for you. 

Disclosures

Q.ai is the trade name of Quantalytics Holdings, LLC. Q.ai, LLC is a wholly-owned subsidiary of Quantalytics Holdings, LLC ("Quantalytics"). Quantalytics offers automated financial advice tools through Quantalytics Investment Advisors, LLC ("QAI"), an SEC-registered investment advisor. QIA’s investment advisory services are ONLY available only to residents of the United States. Disclosures concerning QIA’s investment advisory services are available on its Form ADV filed with the SEC. The content in this newsletter is for informational purposes only and does not constitute a comprehensive description of Q.ai's investment advisory services.

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