When you buy on margin, you use money you don't have to buy stocks.
If you buy 100 shares of a stock that costs $50 per share, you'll have to pay $5,000. You own them. You have paid for them in full.
But when you buy on margin, you get the money you need to buy the stock by borrowing it. You don't have $5,000 to buy those 100 shares, for example. You could borrow up to 50% of that from a brokerage firm so you could buy the stock. To buy the 100 shares of stock, you only need $2,500.
Most brokerage firms require at least $2,000 in equity to open an account. This means that if you want to buy stocks, you have to put in at least $2,000.
You pay interest in exchange for the loan. With your loan, the broker is making money. Your stock will also be held as collateral for the loan. They will take the stock if you don't pay. They don't have much to lose in the deal.
One way to think about buying on margin is like getting a mortgage to buy a house. You are getting the loan in the hopes that the value will go up and you will make money. You now have twice as many shares as before. All you have to do is make sure that the extra profit you make is more than the interest you paid the brokerage.
But there are risks when you buy stocks on credit. Your stock price could always go down. By law, the brokerage can't let the value of the collateral (the price of your stock) drop below a certain percentage of the loan value. If the stock falls below that amount, the brokerage will send you a margin call.
When you get a margin call, it means that you have to pay the brokerage the amount of money needed to bring the brokerage's risk down to the level that is allowed. If you don't have the money, the loan will be paid off by selling your stock. If any money is left over, it will be sent to you. Most of the time, not much of your original investment is left over after you sell the stock.
If you buy on credit, you could make a lot of money. But there is a chance that you could lose the money you put into it. When you borrow money to buy stocks, the risks are higher than when you use your own money.
Buying on credit is usually not a good idea for a new investor or an investor who does this every day. It is something that even the most experienced investors have trouble with. There can be a lot at stake. Make sure you know about all of the good and bad things that could happen.
