Margin Account - A Successful Tool Used To Make Profit

Unlike a cash account, this kinda of account allows an investor to buy securities with money that he/she does not have, by borrowing the money from the broker.

Since this kind of account is a credit account, when an investor buy securities on margin he or she borrows all or part of the purchase cost with the securities.

So, as opposed to the brokerage cash account, which is a simple account to buy and sell securities using cash, margin account requires signing a margin agreement with the brokerage firm and payment of certain interests on the borrowed money to the brokerage firm.

Advantages and Disadvantages

A word of caution: The decision to borrow margin funds - or not - is yours. But if you choose to borrow, you must bear in mind that although trading on margin can offer greater potential returns, it also carries greater risk, and is not suitable for all investors.

· When the value of the stocks rises, you stand to improve your returns because you were able to purchase more shares.

· If the value declines, you could lose more money than you put in your account because you have to repay the amount you borrowed. Consequently, margin transactions carry greater risk.

Illistrations of Margin Accounts In Use

Suppose you bought on margin 1,000 shares of an Internet stock for $10 a share. You put up 50% of the stock's purchase price ($5,000) and borrowed the other 50% from the brokerage firm.

Next year, the stock is valued at $30 per share. If you sell the stock and repay the broker, you are left with close to $27,000 after commissions and interest charges. That is even better for a $5,000 investment.

But consider the consequences if your share price had dropped to $8 dollars. In the cash transaction, you would receive about $38, 00 back excluding commissions, from your original $5,000.

In the margin transaction, you would receive $7,600, repay the $5,000 you borrowed from your broker, and you would be left with $2,600 of your original $5,000, excluding commissions and interest.

Note: Using the leverage that margin buying power provides, you can increase the size of your portfolio, balance your holdings or diversify your portfolio. Qualified customers can use margin to sell short, hedge or trade options. Also remember that in many cases, the interest investors’ pay on margin balances may be tax deductible against other taxable investment income.