In the financial sector, the term “margin” refers to a form of collateral that the holder of futures contracts, options, or other securities is responsible for depositing in order to cover the counteract party’s credit risk. In most instances, that counter party is either a broker or financial advisor. That risk is incurred by a securities holder that has:
- borrowed cash from a another party in order to purchase options or other securities
- got involved in a futures contract
- sold options or securities short (i.e. a short sale or short selling)
Additionally, that collateral can take the form of either cash or other securities. This is usually deposited into what is called a “margin account” that you establish when going through a brokerage in order to purchase stocks. The terminology “margin” used to be referred to as a “performance bond.”
WHAT IS MARGIN BUYING?
Margin buying refers to the practice of purchasing securities with the funds that were loaned to you by your broker/ brokerage account while putting up collateral by using another form of security. This method does have the tendency to magnify any losses or profits that are realized on these types of securities. The net value is defined as and determined by the difference between the value of the loan and the particular security in question.
It is normally equal to the investment that was placed up front but is required to remain above a minimum margin amount established by that particular broker. This insures that the broker is protected against a decrease in value of those securities to the extent that the person investing the money cannot cover the loan. Additionally, there are 4 different forms of margin requirements as follows:
- additional margin
- current liquidating margin
- premium margin
- variation margin
THE ADVANTAGES OF PURCHASING ON MARGIN
The key advantage to making margin buys is the fact that you can leverage the amount you invest in larger, more substantial yields. Just like businesses or corporations borrow money in order to in projects that have potentially profitable returns, the same holds true when you are borrowing and leveraging that cash that you are investing. When you practice leveraging your investment, this amplifies every aspect when a stock increases in value. If you are careful, and you invest wisely you can increase the size of your gain substantially.