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Margin account investing is a great way to really amp up the earnings of your portfolio without actually having to put more of your own money in.  You can borrow up to 70% of the value of an investing in a stock which means you only need to put up 30 cents on the dollar.  Of course there is added risk that naturally comes along with added reward but if you’re interest is piqued read the following on Margin Accounts.

What Is A Margin Account?

Margin accounts are setup to allow clients to buy and sell stocks on credit and requires them to pay part of the full transaction price.  The brokerage firm the client uses lends the remaining capital to the client and charges interest on the loan to the client.  The client is expecting to make much more money than the interest charged out on it, and therefore a little interest is not a deterrent for the added service the firm provides.

The word margin itself refers to the amount of money that the client herself has to put up.  The remaining amount is the loan provided by the brokerage firm.  There are two types of margin positions that can be taken by an investor; long margin positions and short margin positions.

Margin Positions

A long margin position is when the investor buys a stock using only a portion of their own money and borrowing the remaining amount from the broker.  There are specific levels of money that a brokerage firm is willing to loan out which is based on the selling price of the security.  Each quarter there is a document produced that lists the stock eligible for reduced margin.  These are generally stocks that have less risk and very liquid as such, they require you to only put up 30% of the total investment.  The following is a list of those percentages:

Stock Price Maximum Loan Value
Reduced Margin Stock 70% loan
$2.00 and above 50% loan
$1.75 to $1.99 40% loan
$1.50 to $1.74 20% loan
$1.49 and below No loan

Taking a short position in a stock is selling a position in a stock that you don’t currently own.  This type of transaction is executed on the belief that the price of a stock is going to fall.  The terms of margin are the opposite when taking a short margin position because you are actually lending money to the brokerage firm because you technically sold a stock to them and they are paying you the proceeds.  To cover the risk in this situation though the client must put up more than the total value of the short sale.  The following is a list of the maximum loan values for short positions:

Stock Price Maximum Loan Value
Reduced Margin Stock 130% loan
$2.00 and above 150% loan
$1.50 to $1.99 $3 per share
$0.25 to $1.49 200% loan
$0.24 and below 100% loan + $0.25 per share

Margin Call

When the margined stock is purchased the account must maintain sufficient funds to cover the position value. The brokerage firm lends you money but you are also provided with the stock so the full value of the investment is contained within your portfolio.  However if the price of the stock goes down your investment total will be less than the loan amount.  In this case a margin call will be triggered.

Example Of A Margin Call

Client A would like to buy 100 share of OPC.TO at $2.87
Total Cost of Shares $287.00
Maximum Loan (50% * $2.87) - $143.50
Total Margin $143.50
…time passes and share drop to $1.83
Original Total Cost $287.00
Revised Maximum Loan (40% * $1.83) - $ 73.20
New Margin Requirement $213.18
Original Margin Amount - $143.50
Margin Call Amount $ 70.30

In the example shown above you would need to fund the account with an additional $70.30 immediately or have the position liquidated automatically by the brokerage firm.  That’s not something you want to have happen so it’s important to keep a good amount of money in your margin account and try not to come too close to the limits.

Using other peoples’ money to invest can lead to a rapid increase in profits but comes at an increased risk.  When using leverage always take care ensuring that your account won’t come anywhere near a margin call.  That type of situation could result in significant losses as the use of leverage amplifies the loss.  Although many penny stocks don’t use margin, there are still some junior companies that would be eligible in the sub $5 range that could be traded in a margin account.