What Is Margin Trading?
Answers from an Investment Fraud Attorney
Buying on margin is a tactic certain investors use to increase their purchasing
power and, hopefully, their investment return. When buying on margin,
an investor borrows part of the funds needed to purchase a security from
his or her brokerage firm. While buying on margin carries a potential
for greater reward, it also carries increased risks—including the
potential to lose more money than was initially invested. The security
itself is considered collateral on the loan. As such, the firm has the
right to sell the security without informing the investor beforehand.
Brokers have a duty to inform their clients of these risks prior to accepting
purchases on margin. If an investor suffers losses after buying on margin
and was not informed of the risks associated with borrowing from the securities
firm, the broker and the brokerage firm may be liable for margin trading
abuse. Additionally, if a broker engages in margin trading on behalf of
a client without first informing the client that a margin account is being
opened, the broker can be held liable for any losses associated with buying
Understanding the Risks of Margin Investing
Margin investing, also referred to as margin trading, can result in substantial
loss. While some investors understand the associated risks, brokers are
often less than upfront about the downside. Before delving into the risks
of margin trading, you need to understand what it entails.
Investors are generally drawn to margin trading due to the potential to
increase their return on investment. For example, if they are able to
borrow 50 percent of the cost to purchase a stock, they are in essence,
doubling the possible gain on that investment. Of course, brokerage firms
like margin trading, because it allows them to earn interest on the money
that was borrowed; however, there are some significant risks to margin
investing that every investor needs to know.
These risks include, but are not limited to, the following:
Potential for high losses.
With margin trading, you take the risk of losing more money than what
was invested. That is because you leveraged part of the money needed to
purchase the investment.
The security purchased is viewed as collateral for the loan made. That
means that the firm has the authority to sell it, without letting you
know before the transaction takes place.
Costs are great.
When you utilize a margin account, you are looking at interest costs,
fees and commissions.
If you have lost money due to misconduct in your margin investment account
or if your broker traded in your account on margin without your permission,
you could have a broker fraud claim. Call us today to learn more.
We proudly offer free and confidential consultations.
Attorney Chad Kohler offers additional information on the risks of margin trading.