Margin

Borrowed money used to buy securities; amplifies gains and losses.

Margin is the practice of borrowing money from a brokerage firm to purchase securities, using the assets in the investment account as collateral. This allows investors to buy more shares than they could with their cash balance alone, effectively leveraging their investment capital. The amount of margin an investor can use is regulated, typically requiring an initial deposit of cash or eligible securities to cover a portion of the purchase price. Investors use margin to amplify their potential returns. If the purchased securities rise in value, the investor keeps all the gains minus the cost of the borrowed funds and interest. However, margin also amplifies losses. If the value of the securities falls, the investor's equity decreases at a faster rate, and they are still obligated to repay the full amount of the borrowed money plus interest. Using margin introduces significant risks, most notably the margin call. If the account equity falls below a certain percentage, known as the maintenance margin, the broker will demand that the investor deposit more cash or sell securities to pay down the loan. If the investor fails to do so promptly, the broker has the right to liquidate the assets in the account without the investor's consent, often at a loss, to cover the debt.

An investor wants to buy $10,000 worth of stock but only has $5,000 in cash. They use a margin account to borrow the remaining $5,000 from their broker. If the stock price rises by 20%, the total investment is worth $12,000. After selling the stock and repaying the $5,000 loan, the investor has $7,000, representing a 40% return on their initial $5,000 cash (excluding interest fees). Conversely, if the stock price falls by 20%, the investment is worth $8,000. After repaying the $5,000 loan, the investor is left with $3,000, representing a 40% loss.