Purchasing securities “on margin” equates to investing with borrowed funds.
The risks of trading on margin are unsuitable for many investors. If a financial adviser encourages margin trading without regard for a client’s investment profile, or without a client’s full understanding of the risks involved, the client can potentially seek to recover any money lost as a result of the margin transaction.
What is buying on margin?
An investor can buy securities using money borrowed from a brokerage firm (rather than paying for the securities in full). This is known as “buying on margin.”
Buying on margin requires opening a margin account and depositing an initial amount of purchased securities. The initial account equity (margin) is used as collateral to borrow money and purchase additional securities. Like other types of loans, interest is charged on the amount borrowed until it is repaid.
Margin Trading Risks
The risks involved with trading on margin include:
- Securities purchased on margin do not break even, or earn at least the amount of interest charged on the loan, resulting in the loss of funds.
- Securities used as collateral drop in price and the firm issues a “margin call,” which requires the customer to repay all or part of the loan. The customer is not entitled to a time extension on a margin call.
- The client has limited control over their margin account. For example, the firm can force the sales of margin account securities without notice, sell securities without contacting the client, and increase margin requirements at any time.
Margin Account Abuse
Margin investing isn’t an appropriate strategy for most investors. Margin loans, however, can be highly profitable for brokerage firms (because of the interest paid on borrowed money) and for brokers, who might be paid a fee based on the size of the client’s loan.
Investment professionals must understand a client’s investment profile, including their willingness and ability to incur risk. Before a client opens a margin account, they should fully understand how margin transactions could affect their portfolio.
If your broker misrepresented the risks of a margin account, opened an unauthorized account in your name, or made excessive trades in your account, any lost money may be recoverable through a legal claim.