How does margin account work

In other words, your loss is not limited to the value in your account. This makes margin accounts riskier than cash accounts. Margin accounts may also come with unexpected margin calls, where a firm requires you to pay up because your equity in the margin account has fallen below the maintenance margin.

In that case, you can either sell some of your securities or deposit more assets into the account. Firms usually give two to five trading days to meet the call, but they may give a shorter window as they see fit. Brokers are not required to call you before the sale, and can typically select whichever securities they want to sell. Keep in mind that a firm can adjust the required maintenance margin at any time without letting you know.

This is how brokers balance their risk. Plus, shorting a stock can go badly. Investing Essentials. Risk Management. Trading Basic Education. Your Privacy Rights.

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The collateral from this loan is the stock you purchased with cash. Here's an example:. This is the most important aspect of margin accounts to understand, because it works just like any other loan collateral -- if the broker thinks you can't repay what you borrowed, he or she can repossess those shares. Where margin stocks are concerned, this is a lot worse than the bank taking your car because you missed too many payments.

Because of the minimum margins and maintenance minimums you have to keep on the account. We'll explain those in the next section. When the stocks you bought on margin increase in value, everything is fine. You can use the increase in value to repay the loan portion of the investment to your broker. If the stock's value drops, however, you can get into trouble quickly. That's because of the minimum margin. The Federal Reserve Board only allows you to borrow up to 50 percent of the total cost of stocks you buy on margin.

Finally, FINRA also requires a maintenance minimum of 25 percent, which is the minimum amount of cash that must be held in a margin account relative to the value of the stocks.

Brokers can set different minimum margins and maintenance minimums, as long as they are more stringent than the federal rules. They often tie maintenance minimums to the perceived volatility of the stock -- if they think there's a good chance the stock's value will drop drastically, the maintenance minimum might be as much as 75 percent. This can be a problem because the value of your stock declines comes out of your equity first. If the stock's value drops even further, things get much worse.

That's when the broker issues a margin call in the form of a phone call or e-mail. Read the next section to find out why a margin call could spell disaster for your investment portfolio. A margin call is never good news. It means that your margin account's equity has dropped below 25 percent of the account's total value or some higher percentage, if your brokerage agreement requires a more stringent maintenance minimum.

That's less than 25 percent, so the broker issues a margin call. That means you have a limited amount of time -- usually a day or two, as spelled out in your brokerage agreement -- to put enough cash into the account to bring it back up to the 25 percent maintenance minimum.

This is why it's strongly recommended that you have the cash reserves to make a margin call if you plan to buy stocks on margin. If you can't make the margin call in time, the broker can sell off the stocks to bring your account back to the maintenance minimum.