A margin account is one that lets you leverage the value of your brokerage account by borrowing against its value. While a margin account lets you own more securities than your cash account can pay for and thus make additional gains available to you, there is a downside. If the stocks in your portfolio start to go down in value, you may be subject to a margin call which requires you to add more cash to your account or risk the arbitrary selling of the securities in the account.

Margins can be a tempting side of the stock market.  While they have a potential for big gains, they also have potential for big losses.  Here are some thoughts to help you decide whether trading margins is right for you.
Marginable securities are considered collateral, and you will have to pay interest; thus, you will see your debt level rise with time if you do not pay on the loan.  Most people use margins for short-term investments because of this cost factor.

You cannot purchase all stocks on a margin.  Penny stocks, IPOs, and other instruments may be excluded because of risks.  Your broker may also exclude certain stocks on a day to day basis.

Gambling with margins

In other words, you lost more than you started with. Trading margins operate with the same risks.You can compare margins trading to gambling in Vegas.  You are dealt a good hand, but do not have the money to increase your bet.  A friend offers you some cash.  If you win, you will make your friend’s money and your own back, as well as plenty to spare.  If you lose, you are down the money you bet, in addition to your friend’s loan.

While it is not the same as gambling, margins can be a very high-risk strategy.  Choose the right picks, and you make a huge profit; choose wrong, and you will see your portfolio crash into the red.  You must understand stocks well before even thinking about margins.

The benefits of trading margins

The main reason investors choose margins is because of the leverage.  As the stock goes up, your leverage increases.  This means that if you have picked the right investment, you will see a huge return.  If you use the entire 50% initial margin, it means that you can buy twice as many shares as you could on your own.  That just leaves you with the question as to whether or not your stock will increase.

To understand this, you may imagine that you buy $20,000 worth of stock.  $10,000 of this was with your own money, and the other $10,000 was margin.  The stock you choose is currently $100 a share.  You are able to buy 200 shares with the help of your margins, instead of the 100 you could buy on your own.  The company then makes some savvy business choices, and the stock shoots up to $125 a share.  If you cash out now and pay back the $10,000 you borrowed, you are still left with $15,000 in cash (minus commission and interest).  The stock went up 25%, but you get to see a 50% return on your actual monetary amount.

However, think about the flip side of this trade.  What if your shares drop down to only $75 each?  Deciding to get out now, you sell your stocks, and pay back your broker.  You end up with $5000 (minus commissions and interests) or a 50% loss.  What if the stock drops 50%, down to $50 a share?  You have now lost your entire investment, plus the commissions and interest charges.  As you can see, it can be a risky venture to invest in margins.

If you were only using cash, you could wait for the stock to turn back around, and your losses are not realized until you sell.  However, with a margin account, your broker can sell your stock if the price drops below the marginable value of your portfolio to recoup their losses.  Margin calls are very dangerous and could lead to significant damage to your portfolio and financial health. 

New investors should use extreme caution when using margins and you should always remember that you do not have to margin the full 50%.  Only margin the amount of capital that you can afford to lose.