Margin Trading

With a margin account, an investor can buy more than their own cash would allow. The broker lends the rest and charges interest. The investor's own money in the position is called the margin.

For example, an investor with 5,000 could buy 10,000 of shares by borrowing 5,000 from the broker. If the shares rise by 20% to 12,000, the investor's equity becomes 7,000 after repaying the loan, a 40% gain on their own money before interest.

Leverage works in both directions. If the shares fall by 20% to 8,000, the investor's equity drops to 3,000, a 40% loss. A 50% fall would wipe out their entire investment.

Brokers require investors to keep a minimum amount of equity in the account. If losses push equity below this level, the broker issues a margin call, demanding more money or securities. If the investor cannot meet it, the broker can sell the investments, possibly at a loss. Because of these risks, margin trading is generally suitable only for experienced investors.