Borrowing on Margin
Investors should be cautious about borrowing on margin, as it contains different (and often more significant) types of risk than ordinary investing. Additionally, stockbrokers recommendation to purchase stock using margin can provide the opportunity for Financial Industry Regulatory Authority (FINRA) sales practice violations, and can lead to significant investment loss. Borrowing on margin is fairly complicated and should only be used by sophisticated investors who can tolerate the increased risk of loss.Basic Overview
Borrowing on margin involves borrowing money from a stockbroker or the firm he or she works for in order to purchase securities. One of the reasons this may be appealing is because it can allow an investor to purchase more stock than he or she would be able to without the borrowed money.
In order to borrow on margin, a margin account must be opened by the investor. Under FINRA rules, an initial investment of at least $2,000 is required to be placed in the account. This amount is known as the minimum margin. After the account is setup, an investor can borrow up to 50 percent of the purchase price of a stock or security.
The investor may hold the security for as long as he or she wants. However, when the security is sold, proceeds first go to the stockbroker to pay back the loan. Another issue is that the investor must maintain a minimum account balance, known as the maintenance margin. If the account balance falls below this minimum, the stockbroker will require the investor to either deposit more money or sell stock to pay down the loan amount. This process is called a margin call. Importantly, a firm can sell an investor’s securities without discussing it with them in order to meet a margin call.
As a result of the way in which borrowing on margin works, there is the risk that more money than the initial investment will be lost. This is because the amount borrowed must be paid back, regardless of whether the stock increases or decreases in price. Additionally, if the price of the stock decreases sharply and the investor does not deposit additional funds, the firm can sell that stock. This will eliminate the possibility of recovering in the event the stock rebounds and increases in price. In other words, if the firm sells the stock, the investor is “locked in” to losing the investment because he or she no longer owns the stock.
If you are considering borrowing on margin, it is important that you understand fully how the process works and the risks involved. Complete your research first to make sure you are comfortable with this investment option to help avoid issues from developing later.Helping Investors
In some cases, stockbrokers may encourage investors to borrow on margin when it is unsuitable. If the investor suffers loss as a result of this, it may be possible to recover under the FINRA arbitration process. For more information, contact an experienced securities law attorney today. At the Silver Law Group, we provide comprehensive help for investors interested in utilizing FINRA procedures.