What is the benefit of a Margin Account?

Question

Hello there I dont know anything about a Margin account for stocks.....could you please explain how this system works and the pros and cons of it?

Answer 1

How much cash does it take to buy a $200,000 house?  For most people with good credit, somewhere between $5000 and $40,000.

What is the difference between the $200,000 purchase price and the $40,000 cash you put down on the house?  Margin.

On the other hand, without a margin account, if you want to buy $200,000 in Yahoo Inc common stock, you must put down $200,000 cash within three days.  

Pro:  leverage increases the size of your gains.

Con:  leverage increases the size of your losses.

Since most people feel twice as much pain in a loss as they fell pleasure at in a gain;  the wise advice is very clear:  don't use it.

Answer 2

buying a stock on Margin means that you are borrowing a portion of the cost and paying interest on what you borrow.  The pro is that you can buy the stock now and then move cash to cover the loan.  The con is that if the stock declines, you can lose more than you paid for it and STILL have to pay the debt.

Answer 3

Margin accounts let you borrow against the value of your holdings / cash to buy or short a greater value of stock.

Cons:

Since you are borrowing, you will be charged interest on those borrowings.

If the value of your underlying holdings sink, your margin balance will go down.  You could therefore be forced to close positions to generate cash - see the downfall of LTCM as the prime example

Pros:

By utilizing leverage, you can generate much larger $ gains (or losses) on a position than you would be able to otherwise.

Answer 4

First of all, having a margin account simply means that you can use securities (usually stock and bonds) in your account as collateral.

As of the time I am writing this, there have been three other responses, all of which discussed the pros and cons of using that collateral to borrow money to buy more stock.

There are, however, many other ways you might want to use the collateral available. For example, if you want to sell a stock short you will not borrow any money from the brokerage, but the brokerage will require you to have a margin account. The collateral is required to make sure you have enough funds to repurchase the stock even if it increases in value.

Similarly, there are some types of options transactions that can only be done in margin accounts.

A margin account also eliminates free-riding restrictions. (If you are not familiar with free-riding see

http://en.wikipedia.org/wiki/Free_riding )

Finally, a margin account allows you to borrow money from your broker for purposes other than making additional investments.

The only con associated with a margin account is that it allows you more ways to make mistakes. I would recommend you get a margin account but rarely, if ever, borrow money from your broker for any purpose.