According to the US Securities and Exchange Commission, a margin account is “a type of brokerage account in which your broker-dealer. lends you cash, using the account as collateral, to purchase securities.”
Margin accounts can offer faster and easier liquidity. Buying on margin means investors have the opportunity to amplify returns, only if investments outperform the cost of the loan itself.
Although margin accounts can increase your purchasing and trading power, it also exposes you to potential losses, which can mount quickly.
Like all investments, ensure that you fully understand how a margin account works and what happens if the price of the securities purchased on margin declines. Not all securities can be purchased on margin.
Your broker will charge interest for borrowing money, so be sure to ask how that will affect your return on investment and if a margin account is suitable for you.
Here are some potential risks to margin accounts:
- You can lose more money than you have invested;
- You may have to deposit additional cash or securities in your account on short notice to cover market losses;
- You may be forced to sell some or all of your securities when falling stock prices reduce the value of your securities;
- Your brokerage firm may sell some or all of your securities without consulting you to pay off your margin loan;
- You are not entitled to choose which securities your brokerage firm sells in your accounts to cover your margin loan;
- Your brokerage firm can increase its margin requirements at any time and is not required to provide you with advance notice; and
- You are not entitled to an extension of time on a margin call.