Trading on margin is similar to a loan from a bank; only you are borrowing funds from your brokerage firm to purchase stock. Trading on margin allows a trader to purchase stock with less funds than with a regular trading account. It is necessary to obtain approval to open a margin trading account, and there is usually a minimum balance required. The minimum can vary by broker. Options are not eligible for margin trading in a regular (Reg-T) margin account. Once a margin account is approved and opened, a trader can “borrow” up to 50% of the purchase price of a stock. Not all stocks qualify for margin trading. For example, penny stocks and initial public offerings (IPOs) are not marginable because of the high risk involved with these types of stocks. Just like a loan from a bank, trading on margin has costs associated with it. You can keep your “loan” as long as you fulfill your obligations. Stocks that you purchase on margin are collateral, and there will be interest charged on the loan. When you purchase stock in a margin account, as you sell shares the proceeds for the sale go to your broker to repay the loan until it is paid in full. There is “maintenance margin” associated with a margin account, which is the minimum account balance you must maintain in the account. If the account balance drops below this minimum, you will receive what is called a “margin call” from your broker. A margin call will require you to deposit additional funds, or sell some of stock, in order to bring the account balance above the minimum. If for any reason you are not able to meet a margin call, the brokerage firm has the right to liquidate stock positions as necessary in order to bring the account balance above their minimum. A rather unsettling thought is that some margin agreements state that the broker is not required to notify you before liquidating some of your stock holdings, which may result in the sale of stock from your account without your knowledge. It is critical that if you are planning on trading stocks on margin, you read and understand thoroughly your broker's margin agreement very carefully.
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