Margin Requirements

A margin requirement is the minimum amount an investor must deposit, which is usually a percent of the market value of the security being invested in. The deposit is allowed to be greater than the margin requirement, but never less.

The New York Stock Exchange and the Federal Reserve has clear rules regarding futures margin requirements. Much of this is because a person may borrow on margin. This means that they can borrow money to make a trade as long as they have something that they can use as collateral. For instance, a person borrows on margin to purchase 100 shares of stock. They then get to use the 100 shares of stock as collateral. That way if the margin loan is defaulted upon, the brokerage who issued the loan can take that 100 shares to satisfy the amount borrowed and defaulted upon.

However, before a person can do this, they must make a deposit in the form of eligible securities or cash that meets the margin requirement for that purchase.

Buying on Margin

Once you begin buying on margin, a minimum amount of equity must be maintained within your margin account. Investors should have at least 25% of the market value of their investments in their margin account. This is so the account can be maintained. The percentage is more or less maintained all across the board unless otherwise specified. There may be some securities that require just 20%.

If you are a pattern day trader, then your margin requirement is $25,000 in order to maintain the account.

If you were to purchase 100 shares of a stock at $100 per share, the total investment is $10,000. However, you only have $5,000. So what you will do is put down your $5,000 and then borrow $5,000 on margin. This equals your entire stock value of $10,000.

If you have a 25% increase in your stock, you gain $25 per share. At 100 shares that is $125 per share and you own 100. This means your profit is now $2,500. The stock value is now $12,500 versus the $10,000 you started with.

But what if the stock drops? Well, let's say you have a 25% decrease, which means the price goes down to $75 per share. In this case, you're taking a $2,500 loss and now you have $7,500 in shares versus the $10,000 you started out with.

Maintaining Margin

If you find that your stock drops, then you may have to add additional money to the margin account in order to maintain it. So if you are $2,500 in the negative, you will need to add funds in order to maintain your $10,000 deposit.

You can talk to your advisor about using real-time margining so that you can see your risk at any time during the day. For instance, your margin requirement can change at any point of the day. If you fall $500 below the $10,000 that you deposited, then you will need to deposit $500 to maintain your end of the deal.

In volatile markets there is a degree of risk that comes with borrowing on margin. There is a risk for the broker and a risk for an investor. For instance, what if you find that you cannot deposit enough money to maintain your margin? If that happens, then the broker has the right to remove shares in order to call it even. They can then reimburse themselves with the sale of those shares. The concept is rather simple. If it seems like an expensive concept to some, it is what can be profitable for a person, although the risk is always there - so make sure you're familiar with margin requirements.

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