Margin Trading Rules and Requirements for Investors
Margin trading rules are in place to protect both the investor and your brokerage. However, many investors aren’t familiar with trading on a margin. Is this a popular strategy? And what rules or guidelines are you required to meet?
These are fair questions that all investors must consider before becoming a margin trader. Let’s take a closer look at this strategy below.
What is Margin Trading?
The U.S. Securities and Exchange Commission (SEC) has a number of guidelines for margin trading. In fact, it is the SEC’s mission to “protect investors and maintain fair, orderly and efficient markets.”
So, how does margin work in trading? It is the act of borrowing money to invest in a particular stock or security. And when you buy on margin, you are borrowing from the brokerage in which you place your trades.
For example, let’s say you want to buy a stock worth $100 a share. Normally, you would pay for the stock in full. But margin trading rules allow you to buy the stock for $50 while borrowing the remaining $50 from the broker.
Eventually, you will have to pay back the brokerage firm the $50 that you borrowed plus interest. But if the stock price climbs, that makes it easier to pay off and your return on your direct investment increases.
Sounds great right? Well, not so fast. This works the same if the stock price decreases. Let’s say that same stock drops from $100 to $50. If you paid for the stock on your own, this would be a 50 percent loss. But if you made the trade on a margin, you would lose 100 percent. Moreover, you would have to pay off the interest as well.
As you can see, you can actually lose more money than your original investment with margin trading. Along with market volatility, this is a major risk that many investors are not willing to take on.
Margin Trading Rules Overview
So how does the SEC protect its investors? For starters, the SEC refers to the margin trading rules put in place by the Federal Reserve Board and the Financial Industry Regulatory Authority (FINRA).
FINRA sets the minimum margin requirements. Overall, FINRA requires you to deposit a minimum of $2,000 or 100 percent of the purchase price, whichever is less, with your brokerage firm. Some brokerages may require you to deposit more.
And there’s also a maintenance requirement. This requires you to have at least 25 percent of the total market value of the securities in your margin account at all times. And to be clear, this is a minimum requirement. Most brokerages will require between 30 to 40 percent or higher.
Lastly, one of the most important margin trading rules to understand is Regulation T of the Federal Reserve Board. This states that you can “borrow up to 50 percent of the purchase price of securities that can be purchased on a margin.”
And just like the other rules above, some brokerages may require you to deposit more than 50 percent of the purchase price. In addition, not all securities can be purchased on margin in the first place.
Margin Investing and Brokerage Firms
Some of the most popular investing platforms provide investors with the ability to trade on a margin. So, it’s important that you do your research. Each brokerage will have its own set of guidelines and minimum requirements for margin trading.
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The margin strategy comes with risks that many investors shy away from. If you have still an interest, make sure to consider these margin trading rules before making the commitment.