What is Margin Trading and How Does it Work?

What is a Margin Account?

A margin account allows you to borrow funds from your broker to purchase securities and use these securities as further collateral. The ability to borrow money gives you both the potential for more profits but also more losses.

Unlike a cash account, where you can only trade with the cash balance in your account, a margin account leverages your assets in your account into more buying power. Borrowing incurs interest expenses on the margin used, but it also provides the benefit of potentially greater returns.

You accrue margin interest daily on positions held via margin. This interest is calculated daily on a trade settlement basis, i.e., between an opening and closing trade. If your available cash balance is below $0 or negative on your account with active positions greater than your net liquidation account value, then you are borrowing via margin.

It’s important to understand that not all securities are marginable. Non-marginable securities include but are not limited to certain stocks, exchange-traded funds (ETFs), and options. Non-marginable securities require full payment upfront. They also cannot be used as collateral for additional margin. Understanding which assets in your portfolio are marginable is crucial for effective account management.

What is Regulation T (Reg T)?

Regulation T, or Reg T, is a rule that governs standard margin accounts in the United States. It is an industry-standard rule that determines margin requirements when opening or maintaining a marginable security within a margin account. Reg T requires that brokers lend up to 50% of the total trade price of a security. Brokers can go above this 50% level but not below it. In simple terms, Reg T is what allows margin account holders to access more capital than what they deposit. Remember, though, this capital is not free to utilize as there are margin interest payments associated with different borrowing amounts.

Learn more about margin interest tiers

The main differences between a margin account and a cash account are the trading strategy permissions and account leverage for each.

Margin accounts allow borrowing to enhance purchasing power. Higher potential returns come with higher risks and interest costs when trading on margin in a margin account. With a margin account, you have more access to complex high-risk options strategies and futures products.

Cash accounts do not have margin ability, offering no leverage and therefore are considered a lower risk portfolio profile. You can only trade with cash in the account and nothing more.

Determining whether to open a cash account or a margin account depends on your personal risk tolerance and desire to trade in a specific way. More flexibility is available in a margin account, where cash accounts are restrictive. Neither is better nor worse, it just depends on your trading objectives and risk profile.

Learn more about margin vs. cash accounts

What is Margin Trading?

Margin trading allows you to take on larger positions by only covering a fraction of the total trade cost. This means more profit or loss for every incremental move in the underlying you’re trading. Each broker has its margin requirements, which specify the amount of capital needed. For tastytrade, factors such as market volatility and the size of your position will influence the amount of margin required. For example, customers with margin privileges get a 2:1 ratio on leverage for stock buying power. In a portfolio margin account, this ratio can grow to 6.7:1. Entity accounts, LLC, S-Corp, and Partnership, can also apply for portfolio margin if certain funding requirements are met.

The key to margin trading is understanding that your notional value risk can be higher than the cash value in your account. This means more return for smaller moves in your favor, but also more risk against you. Unlike fully paid positions in a cash account that can be held perpetually, a move too volatile against you could be troublesome if losses exceed the cash value in your account, which could result in a margin call. Be sure to keep risk in check when trading on margin and have a management plan in place for all market scenarios.

How Does Trading in a Margin Account Work?

The minimum deposit required under Reg T is $2,000. Once your account is funded, you can begin using margin.

For example, if you have $10,000 in your margin account and wish to leverage at the full 2:1 ratio allowed under Regulation T, your buying power would equal $20,000 for marginable securities—$10,000 of your own money plus $10,000 margin. This effectively doubles your buying power if you choose to trade on margin.

In a margin account, the marginable securities you hold can act as collateral required for margin loans. This allows you to borrow against your marginable securities to establish new positions. However, trading on margin involves more risk because it increases your borrowing, may incur interest charges, and can potentially result in a margin call if you don’t carefully manage your account.

See tastytrade's margin interest rates

What is a Margin Call?

A margin call occurs when the value of your securities held drops below the maintenance margin requirement set by your broker. The margin call is often due one business day (T+1) after the call is issued. The fastest way to resolve a maintenance call is by closing positions to free up available capital.

Alternatively, you can deposit more funds into your account. Sometimes the market can move back in your favor to resolve the margin call; however, waiting on such movement is not advisable since it is subject to unknown market conditions.

Failure to meet a margin call can result in the liquidation of some or all of your positions to cover the deficiency, often without prior notice. Because of this, it is important to carefully and regularly monitor your positions.

Trading on Margin Example

You’re considering purchasing a $30 stock and have $3,000 available in your margin account. With a 2:1 leverage ratio, your stock buying power is $6,000, allowing you to purchase up to 200 shares using margin. Your initial investment totals $6,000, and that is also your total risk. If the share price increases to $40, your unrealized investment is valued at $8,000. After closing the shares, you will cover the $3,000 margin loan. Your profit is $2,000 with a cash value of $5,000.

In a cash account, you can only purchase up to 100 shares at $3,000, which would result in a profit of $1,000 in this example.

Conversely, if the share price drops to $20, your unrealized investment value falls to $4,000. After closing the position and covering the $3,000 margin loan, you're left with $1,000, incurring a $2,000 loss.

If the price had plummeted further to $10 per share, your unrealized investment would fall to $2,000, but you still owe $3,000. Paying the difference results in a $4,000 total loss, which is $1,000 more than your initial cash balance. Illustrating the amplified risks alongside the gains can help you avoid unwanted margin calls, which this example would have resulted in.

If you purchased 100 shares in a cash account, the loss can be more sustainable, as you would be able to maintain your position for as long as you desire.

Keeping total risk in mind when trading on margin is crucial to better emphasize the importance of being able to trade through inevitable volatility.

How to Start Trading on Margin

1. Open a tastytrade margin account: Begin by creating an account with tastytrade to access margin trading privileges
2. Fund your account: Deposit at least $2,000 in cash to meet the minimum requirement for margin trading
3. Select your investment: Choose stocks or ETFs to potentially trade on margin based on market analysis and investment goals
4. Open, monitor, and manage positions: Open your trades, keep track of market movements and positions, and adjust as necessary for market conditions