Can Someone Briefly Explain Margin Accounts To Me?

Q: Can anyone tell me the disadvantages of having a margin account or borrowing? Is there any reason why I SHOULDN'T have a margin account? Also, does the ~5.5% interest money market still remain the same when moving cash account to margin?

A: You've got it about right. You may misunderstand your borrowing power
though. As I understand it, most brokers will let you borrow an amount
equal to the equity in your account to purchase additional stock. 50K
account value means you can purchase up to 100K of stock. If the value
of the stock falls, your equity percentage will also dro

p but cannot go
below 30% of the stocks you own.

Say you opened a margin account with $50,000 cash and bought 1000 shares
of company x at $100/share today. Tomorrow it drops $25 to $75/share.
You now own 1000 shares at $75/share. Your account value has dropped to
$25,000. You still own the 1000 shares but you still owe your broker
the $50,000 you borrowed to buy them. This means your equity is now
33%. Another drop and you will either get a broker's call (for more
money to be deposited in your account) or your stock will be sold to pay
the loan and whatever (if anything) is left will be deposited in your
account.


Be very careful with this. I have a margin account and initially used
it a lot. Only had a small sum of money in there so figured if I lost
it, what the hell. Have substantially more out there right now and I
try to stay pretty much off of margin most of the time. Would never
dream of leveraging the whole account now. Once in a while I might
borrow perhaps 10% more than my account for a short period of time but
not often.


Someone explained it to me this way and it got me thinking.


Our brokers know a lot more about trading stocks than we do. They are
willing to lend you money at 8% rather than put it in the market
themselves. Think about it.