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Buying on margin means borrowing money from your broker to buy securities.
Margin can refer to many things in the world of finance. When it comes to investing, buying on margin means borrowing money from your broker to buy securities such as stocks or bonds. Margin is the difference between the total value of the investment and the amount you borrow from a broker. In essence, you’re using cash or securities you already own as collateral to make further investments in hopes of making a profit. As with other loans, you must pay back the money you borrow plus interest. However, margin trading comes with risks. If the amount borrowed becomes too large in relation to the value of your securities, you’ll have to deposit more money. Otherwise, your broker may sell some of your assets. And remember, even if you lose your entire investment, you’ll have to pay back the borrowed amount with interest.
Let’s say you want to buy $10,000 worth of stock, and your broker requires a 75% margin payment (that’s the percentage of the purchase you’ve to finance yourself). That means you’d have to put in $7,500 of your own money, and in a margin account you could borrow another $2,500 to buy $10,000 worth of stock. As long as you’ve not repaid the loan, interest continues to accrue on the amount borrowed.
Buying on margin is like riding a motorcycle…
Sometimes you want to get to your destination a little faster. With a motorcycle, you can weave through traffic and pass slower vehicles. But it’s also riskier than driving a car. You’ve to weigh the pros and cons and be aware of the risks you’re taking. It’s a similar story with margin. It’s your decision what to do with the money you borrow, but ultimately you’ve to pay for the amount plus interest. If your investments go up in value, that’s great – that could multiply your profits. However, if your investments fall in value, the margin could multiply your losses.