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 on margin.
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 at (888) 390-6491 to learn more. We proudly offer free and confidential consultations.
Attorney Chad Kohler offers additional information on the risks of margin trading: