The Definition of Stock Market Margin
Buying stocks on margin involves borrowing money from your stockbroker to pay for a portion of the stock purchase. Margin stock buying is subject to certain rules, and buying stock on margin can result in dangerous consequences.
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Identification
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Stock market margin is the ability to buy stocks on the "margin" or borrow a portion of the purchase price from the broker. Current SEC rules limit the amount of margin an investor may borrow to 50 percent of the initial purchase price.
Function
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An investor wants to buy 100 shares of a stock costing $50 per share for a total cost of $5,000. In a margin account, the investor would need $2,500 cash for the purchase and borrow the remaining $2,500 as a margin loan.
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Potential
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Buying stock on the margin magnifies the gain when the stock goes up. If the $50 stock goes to $60, the cash buyer made $1,000 on her $5,000 invested, or 20 percent. The margin buyer earned the same $1,000 with only $2,500 invested, or a 40 percent return.
Considerations
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If stock purchased on margin falls in value, the investor's equity must remain above 25 percent or he will be required to either sell the stock and pay back the loan or put in more cash. The requirement for additional cash investment is termed a "margin call."
Warning
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Margin stock buying allows the investor to purchase more stock with the same amount of money. It also exposes them to losses greater than the amount invested if the stock falls significantly in value.
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