Are you an informed investor?
Margin Madness
Margin trading has been available through investment firms for over a century. It has recently moved back into the spotlight showing up on mobile investment apps that put margin trading in the hands of anyone with a smartphone.
A Loan, but with a Securities Twist
Typically, investors use their own cash in their investment account to purchase stocks, bonds, or other securities. Margin trading is an investment strategy where an investor borrows money from a broker-dealer and invests that money as if it were the investor’s own. By trading on margin, an investor could make a $1,000 investment with only a fraction of that amount of cash available in their brokerage account. Trading on margin applies leverage: it amplifies profits if an investment is successful but it also amplifies losses if the investment fails .[1]
Like a traditional loan, investment firms charge interest on the amount borrowed by an investor. These interest rates can vary based on the amount of the loan – typically the larger the loan the lower the interest rate.
Unlike a traditional loan, investment firms impose several conditions on margin loans that could negatively impact an investor whose investment does not pan out. One of the most significant is the margin call. Investors are required to maintain a certain level of collateral in their account so the investment firm knows they will be able to pay back the loan.
If the value of the securities in the investor’s account falls below this threshold, the investment firm will issue a margin call. The investor then has a period of time (ranging from hours to days) to bring their account value back above the threshold, either by depositing more cash or selling securities in the account. If the investor does nothing and the account value remains below the threshold, the investment firm – not the investor – will decide which securities to liquidate in the investor’s account.
Example: Bucky Boxing Glove and Michelle Mitten
Bucky Boxing Glove wants to purchase 100 shares of Badger Cheese, a company currently trading at $20 a share, but he only has $1,000 available to invest. He uses his cash to purchase 50 shares and buys the other 50 shares on margin by borrowing an additional $1,000 from his investment firm, for a total initial investment of $2,000.
Bucky’s investment pays off – Badger Cheese’s award-winning cheeses made from the best organic Wisconsin milk win numerous cheese awards – and the share price rises by 50% to $30. The value of Bucky’s $2,000 investment grows to $3,000. Bucky pays back his loan to the investment firm, along with the interest accrued ($100), but gets to keep the remainder of the gains for a total personal profit of $900. Had Bucky only used his personal cash to invest, his profit would only have been $500.
Bucky’s friend, Michelle Mitten, sees Bucky’s success and also decides to try margin trading. Michelle also has $1,000 to invest and wants to purchase 100 shares of Stolen Peninsula Pens – another company currently trading at $20 a share. She uses her cash to purchase 50 shares and buys the other 50 shares on margin, for a total initial investment of $2,000.
Unfortunately, Stolen Peninsula Pens has a product defect of exploding ink all over its customers, and the company’s share price quickly dips to $10 a share shortly after Michelle invests, bringing the value of her investment to $1,000. Michelle is in trouble – she still owes the investment firm the full $1,000 she borrowed, plus the $100 in interest. Michelle is forced to sell her investment to repay the full margin loan and has to liquidate other securities in her investment account to repay the interest. If she doesn’t have any additional securities to sell, she will have to find the money elsewhere.
Margin Trading Risks
As described above, margin trading can expose investors to greater losses than their initial investment amount. Margin trading also exposes investors to other risks, including but not limited to:
- Irrecoverable Losses. If investors are forced to sell securities in their accounts due to margin calls, the losses are permanent and the investor cannot hold the security to see if it rises in value and even results in future gain.
- Incurring Tax Liabilities. When investors liquidate securities (or the investment firm forces them to do so to cover a margin call), the investor may incur tax liabilities and miss the opportunity to appreciate additional gains while having to pay more in taxes.
- Damage to Credit History. If an investor fails to repay their margin loan to the investment firm, their credit score may drop. This impacts the investor’s future ability to obtain loans or credit from most types of financial institutions.
Tips for Investors Considering Margin Trading
If an investor is considering using margin trading as an investment strategy, they should take the following steps to make sure it is the right strategy for them:
- Do Homework. Investors should ensure that they fully understand how margin trading works, including the potential for losses, before they utilize it.
- Review Contracts Carefully. Investors should review margin loan contracts and make sure they understand the potential consequences of the terms included.
- Due Diligence on Investments. Investors should carefully research the securities before trading on margin. Securities with widely fluctuating values could trigger margin calls and other negative impacts on the investor’s account.
- Risk Tolerance. Investors should review their own risk tolerance to see if margin trading is suitable for their investment goals and needs.
Bottom Line
All investments carry risks. Margin trading magnifies those risks. Investors considering margin trading should ensure they fully understand how the strategy works and the risks involved. Investors with questions about margin trading should consult with a registered investment professional. For more tips and information about how to be a better informed investor, contact your state or provincial securities regulator. Contact information is available on the NASAA website, here.
[1] Another form of leveraged trading is short selling. Margin trading and short selling can be viewed as opposites: margin traders borrow money from broker-dealers to increase the size of their investments (anticipating the investment will increase in value over time) while short sellers borrow securities from broker-dealers to sell in the open markets (anticipating the price will fall and the short seller can then repurchase and return the securities more cheaply later, profiting in the process). Margin trading and short selling can only be done through a margin account at a broker-dealer, and broker-dealers can place limits on their customers’ ability to trade on margin.
Posted: December 2025
NASAA has provided this information as a service to investors. It is neither a legal interpretation nor an indication of a policy position by NASAA or any of its members, the state and provincial securities regulators. If you have questions concerning the meaning or application of a particular state law or rule or regulation, or a NASAA model rule, statement of policy or other materials, please consult with an attorney who specializes in securities law.
