Free Stock Market Course Part 10: Using Margin

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Chapters:
Using Margin to Buy Stocks
Margin
Margin allows for leverage.
Leverage is the ability to control an asset without having all of the required funds available.
Credit, installment loans, and mortgages are forms of leverage.
An asset is allowed to be controlled with an amount of capital much less than the value of the asset.
Margin Requirements
How long an investment is held (either long or short) will determine how margin requirements are calculated.
By default, many brokerages establish margin accounts when an account is opened.
Margin allows funds or stocks to be used as collateral to borrow additional funds.
Since 1974 in the US, the margin rate set by law is 50%.
This allows for 2:1 leverage.
Interest rates are typically low since the loan is fully collateralized.
A stock mut have a price above $5 per share. A stock can lose the ability to be margined.
Margin Rates
Listed below are the current margin rates for Charles Schwab (October, 2021):
Calculating Interest
If $10,000 is borrowed and held for one year:
Interest = $382.50
Interest is debited from an account.
Usually calculated daily:
Divide by 360.
$382.50/360 = $1.0625 per day
Please note that the use of a 360-day year results in a higher effective rate of interest than if a year of 365 days were used.
If held for 30 days = $31.875 Each month is considered to be 30 days.
Uses of Margin
Margin is typically used to buy additional shares of stock.
However, margin can be used for other reasons.
If obtaining a personal bank loan is not desirable or a viable alternative, using a margin loan may be considered.
Why?
Lower interest
More control
Repayment convenience
Interest may be tax deductible
When buying stocks in a margin account, any excess above your cash value used for purchases will be borrowed automatically, up to your available limit.
When it is desired to NOT use margin, don’t exceed the value you deposited.
Two-Edged Sword
Margin can be wonderful if profits are experienced.
Margin can be detrimental if losses are realized.
Regardless of how an investment performs, all borrowed money must be repaid.
Maintenance Margin
There are two types of margin:
1. Initial Margin (50%)
2. Maintenance Margin (25-40%)
Once a stock has been purchased, the account must maintain a certain value level.
If this level is exceeded, this will produce a Margin Call.
To fix this problem:
Sell stocks
Deposit more money
As a rule of thumb, in a fully margined account, a percentage loss will double.
A 5% decline will result in a 10% loss.
Calculating Maintenance Margin
Brokerage firms can vary in the percentage required in a margin account. By law, it is 25% but a broker can increase this amount.
This can be 25%-40%.
Spreadsheet
Risk Assessment
Each Investor must determine if using margin is appropriate for them.
The advantages and disadvantages must be weighed.
It is also necessary to control fear and greed when deciding what to do.
Margin only applies to brokerage accounts. If using Mutual Funds, margin is not used.
Margin Account Needed?
There may be instances when an investor does not wish to use margin to purchase stocks.
However, a margin account may be required if more advanced strategies are to be implemented.
This can include buying or selling options.
It may be desired to set up an account that does not purchase investments using margin but still allows for advanced strategies to be implemented.
Margin Agreements and Disclosures
If a customer trades stocks in a margin account, the customer needs to carefully review the margin agreement provided by the firm.
A firm charges interest for the money it lends its customers to purchase securities on margin, and a customer needs to understand the additional charges that may be incurred by opening a margin account.
Under the federal securities laws, a firm that loans money to a customer to finance securities transactions is required to provide the customer with a written disclosure of the terms of the loan, such as the rate of interest and the method for computing interest.
The firm must also provide the customer with periodic disclosures informing the customer of transactions in the account and the interest charged to the customer.
FINRA.ORG
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