A normal cash account only lets you buy as much stock as you have cash on hand to pay for. A margin account lets you purchase stocks with borrowed money. Cue the red flags and warning sirens!
While margin accounts can increase your returns, they also greatly increase your risk.
“But my broker suggested margin!”
No surprise there. Brokers stand to make a lot of money off margin accounts. How? By charging interest on the borrowed funds. And since margin gives you more (borrowed) money with which to buy stocks, it generates greater commission fees.
Don’t bite if you’re told that margin accounts increase your “buying power.” Buying on margin only enhances your “borrowing power.” You’ll have to pay all that margin money back at some point. And if the stocks you bought on margin have decreased in value when the piper comes to call, you may not have the money to repay.
At that point, your broker reserves the right to liquidate positions in your account to cover the loan. This can leave you with large losses you could have recovered if you had been able to hold onto your positions as they rebounded.
Ultimately, the person who gains the most control in a margin account is your broker, not you. For them, margin is a cash cow; for you, a double-edged sword.
So, let’s recap. What does trading on margin mean?
- Margin accounts allow investors to buy stocks using borrowed funds.
- Margin is a cash cow for brokers, but can cost an investor a lot in interest.
- A broker can force you to liquidate your margin positions before you are ready to sell.
MyWallSt operates a full disclosure policy. MyWallSt staff currently holds long positions in companies mentioned above. Read our full disclosure policy here.
Chief Investor and Co-founder at MyWallSt
Emmet’s first stock was Dell Computers, but it's not his favorite anymore! That honor goes to Tesla, who is producing user-centric products for a global customer base.