Margin Account: Definition, How It Works, and Example

What Is a Margin Account?

A margin account is a brokerage account with which investors are permitted to sell securities short or borrow money to buy securities based on the funds in the account. Unlike standard cash accounts, traders and investors with margin accounts are offered purchasing power well beyond the funds in their accounts, which magnifies both gains and losses relative to their cash position.

To open a margin account in the U.S., investors must make a minimum deposit of $2,000 ($25,000 for "pattern day traders"), sign a margin agreement, and pass the brokerage's screening for credit history, financial stability, and investment knowledge.

How a Margin Account Works

Leverage and Purchasing Power 

Margin accounts provide leverage, enabling investors to take bigger positions than they could afford using their own funds. A standard margin account for stock trading permits investors to borrow up to 50% of the purchase price when they buy stocks that qualify under Regulation T from the Federal Reserve. Leverage magnifies both returns and losses as a percentage of actual holdings.

For example, a trader holding $10,000 in their margin account could buy $20,000 worth of stock, effectively doubling their purchasing power. A 10% rise in the value of that $20,000 of stock would bring a $2,000 gain—20% of the $10,000 in the trader's account. Likewise, a 10% drop in the value of the $20,000 holding would result in a loss of 20% of the funds in the account.

Interest and Costs

Investors who borrow funds on margin must pay interest on the loan they receive. Brokerages offer different interest rates depending on the loan amount, with larger loans usually receiving lower rates. Brokerages establish margin rates by adding a spread to their base rate, which typically results in annual rates falling between 5% and over 12%.

Margin loan interest calculations occur daily, though brokerages typically process the payment by withdrawing funds from accounts monthly. This recurring expense can create a persistent drag on investment performance, diminishing returns over time, particularly when markets trade within narrow ranges or exhibit minimal directional movement.

Margin Calls and Requirements

Most brokerages have clearly stated margin requirements—that is, rules on the amount of funds that must be maintained in the account relative to the value of the holdings bought or shorted on margin. If a margin account's value drops below the required level, the broker will require the account holder to add money to their account. This is known as a margin call. Here are some terms to know:

• Initial Margin: The Federal Reserve's Regulation T governs most margin requirements. For stocks, the initial end-of-day margin requirement is 50%.
• Maintenance Margin: Most brokers loosen margin requirements for holding positions, often requiring only 25% of the value of held securities. Maintenance margin requirements for currencies, futures, and other derivatives are often less than 10% of the value of any holdings.
• Margin Call: When an account's equity falls below the maintenance requirement, brokers issue a margin call demanding additional funding. This typically must happen within 2-5 business days (sometimes fewer in volatile markets).
• Forced Liquidation: If investors cannot or do not respond to a margin call within the required time frame, brokers have the contractual right to sell securities in the account without prior consultation or additional notice. This forced liquidation occurs at the broker's discretion.

Additional Considerations

Trading on margin carries some additional risks, in addition to amplified losses and the potential for margin calls or forced liquidation.

• Rising interest rates: The cost of maintaining margin positions increases with interest rates, further eroding potential returns. In prolonged high-interest environments, margin interest's compounding effect can significantly drag on overall performance.
• Psychological stress: Monitoring leveraged positions and margin levels, especially during high market volatility, can lead to poor decision-making.
• Pattern Day Trader (PDT) Rules: Investors who execute four or more day trades within five business days in a margin account with less than $25,000 will be flagged as "pattern day traders" and subject to additional restrictions.
• Retirement Accounts: Traditional and Roth IRAs generally cannot be used for margin for trading.

Example of a Margin Account

Imagine an investor opens a margin account with $30,000 in cash and wants to purchase shares of XYZ Corporation, which are trading at $100 per share.

Initial Purchase:

• Without margin: The investor could purchase 300 shares ($30,000 ÷ $100 = 300).
• With margin (50% initial requirement): The investor could purchase up to 600 shares ($60,000 worth), using $30,000 of their own money and borrowing $30,000 from the broker.

Scenario 1: Price Rises to $120 per share

• Market value of 600 shares: $72,000
• Gain: $12,000
• Account equity: $42,000 ($30,000 + $12,000)
• Return: 40% ($12,000 on $30,000 initial account value)
• Without margin, the return would have been only 20% ($6,000 on $30,000)

Scenario 2: Price Drops to $80 per share

• Market value of 600 shares: $48,000
• Loss: $12,000
• Account equity: $18,000 ($30,000 - $12,000)
• Loss on investment: 40% ($12,000 loss on $30,000 initial account value)
• Without margin, the loss would have been only 20% ($6,000 on $30,000)
• Margin call: Note that the investor would have received a margin call once the value of the shares fell below $66.67. At that price, the holdings would have had a total value of $40,000. That would represent a paper loss of $20,000, bringing the account value to $10,000—25% of the value of the holdings ($40,000) and the minimum margin maintenance requirement.

Note: For the sake of simplicity, these returns calculated above don't include capital gains taxes or interest owed to the broker for the borrowed funds.

The Bottom Line

Margin accounts are a type of brokerage arrangement where investors can borrow against their portfolios to increase purchasing power or sell short, subject to regulatory requirements, including initial deposits (typically 50% for stocks) and maintenance thresholds (25-40%). The leveraged structure of margin amplifies both gains and losses.

Regulatory safeguards include maintenance requirements, margin call procedures, and broker liquidation rights that activate during adverse price movements. Effective margin utilization requires understanding the relationship between equity, borrowed funds, and total position value to calculate potential outcomes across market scenarios.