A margin account is a type of investment account that allows you to borrow money to purchase additional investments, such as stocks.
Typically, you can borrow up to 50 percent of the value of the account to buy more stocks. For example, if you deposit $10,000 in your margin account, you can typically buy up to $15,000 of stock. You must pay interest on the amount you borrow, as with any loan. The effect of buying stock on margin means both your gains and your losses are amplified. To cash in a margin account, you must pay off your loan.
The main difference between a cash account and a margin account is that in a cash account all transactions must be made with available cash or long positions. When buying securities in a cash account, the investor must deposit cash to settle the trade or sell an existing position on the same trading day, so cash proceeds are available to settle the ‘buy’ order. A margin account allows an investor to borrow against the value of the assets in the account to purchase new positions or sell short. In this way, an investor can use margin to leverage his positions and profit in both bullish and bearish times in the market. Margin can also be used to make cash withdrawals against the value of the account as a short-term loan.
For investors seeking to leverage their positions, a margin account can be very useful and cost effective. When a margin balance (debit) is created, the outstanding balance is subject to a daily interest rate charged by the firm. These rates are based on the current prime rate plus an additional amount that is charged by the lending firm. Margin interest rates are often much lower than traditional loan rates from banks, making them attractive for short-term loans and for buying investments without increasing cost basis too much.