If you have lost a great deal of money while trading on margin on the advice of your stockbroker, you probably are feeling bewildered and upset. Your broker likely told you all the potential benefits of margin trading, but did they advise you of the risks too?
Buying on margin basically means taking out a loan to purchase stock. The lender uses the purchased stock as security against the loan. You can borrow up to 50 percent of the investment’s purchase price under federal regulations, though many brokerage companies have policies limiting margins further than that. The lender, typically the brokerage itself, charges interest on the loan that is automatically added to the margin account monthly. If you later sell at a profit, the proceeds first pay off the loan, with the remainder going to you.
The risks of buying on margin
Margin trading allows you to invest more than you could with your own funds, with a larger potential payoff if the stock price goes up as you and your broker expect. But borrowing money to invest has obvious risks.
Whether the investment pays off or not, you are responsible for the loan. And a drop in stock price can trigger a margin call, which is when the equity in the margin account is too low to meet the maintenance margin requirement. Your broker will then require you to deposit more money into the account, which is called issuing a margin call. Depending on the maintenance margin requirement, this new investment could cost you thousands of dollars. If you can’t afford it, the broker has the right to liquidate the securities without notifying you, even if it means significant losses for you.
Margin trading is a legal, legitimate way to invest as long as you understand the potential risks. If your broker failed to disclose these to you clearly and in full, your might have a claim for compensation for your investment losses.