Some investors have been shocked to find out that the brokerage firm has the right to sell their securities that were bought on margin — without any notification and potentially at a substantial loss to the investor.
If your broker sells your stock after the price has plummeted, then you've lost out on the chance to recoup your losses if the market bounces back. Margin accounts can be very risky and they are not appropriate for everyone. Before opening a margin account, you should fully understand that:.
To open a margin account, your broker will have you sign a margin agreement. The margin agreement may be part of your general brokerage account opening agreement or may be a separate agreement. The margin agreement states that you must abide by the margin requirements established by the Federal Reserve Board, self-regulatory organizations SROs such as FINRA, any applicable securities exchange, and the firm where you have set up your margin account.
Be sure to carefully review the agreement before you sign it. As with most loans, the margin agreement explains the terms and conditions of the margin account. For example, the agreement describes how the interest on the loan is calculated, how you are responsible for repaying the loan, and how the securities you purchase serve as collateral for the loan.
Carefully review the agreement to determine what notice, if any, your firm must give you before either selling your securities to collect the money you have borrowed or making any changes to the terms and conditions under which interest is calculated.
In general, a firm must provide a customer at least days written notice of changes in the method of computing interest. Here are some of the key rules you should know:. The equity in your margin account is the value of your securities less how much you owe to your brokerage firm. However, many brokerage firms have higher maintenance requirements, typically between 30 to 40 percent, and sometimes higher depending on the type of securities purchased. Here's an example of how maintenance requirements work.
But if your firm has a maintenance requirement of 40 percent, you would not have enough equity. If your account falls below the firm's maintenance requirement, your firm generally will make a margin call to ask you to deposit more cash or securities into your account. When a margin call occurs you generally cannot purchase any additional securities in your account until you satisfy the margin cal l requirements.
If you are unable to meet the margin call, your firm will sell your securities to increase the equity in your account up to or above the firm's maintenance requirement. However , your broker may not be required to make a margin call or otherwise tell you that your account has fallen below the firm's maintenance requirement. Merrill offers a broad range of brokerage, investment advisory including financial planning and other services.
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Tools and calculators. Contact us. Open an account with Merrill. Think of short selling as a kind of mirror of conventional stock investing. Short selling involves much more risk than buying a stock long in the hopes the price increases. You ultimately must repurchase the stock that you borrowed and then sold.
The more the stock gains in value, the more money you stand to lose. This is in contrast to normal investing, where losses are capped by the amount you originally paid for a stock. With short selling, there is no maximum to losses.
If your instinct is wrong and the company doubles in value, you must buy back shares at twice the price you sold them for. This helps ensure the investors whose stocks you borrow are protected from the chance of you defaulting on a short trade. I'm a freelance journalist, content creator and regular contributor to Forbes and Monster. Find me at kateashford.
With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for Bankrate and LendingTree. Select Region. United States. United Kingdom. Kate Ashford, Benjamin Curry. Contributor, Editor. Editorial Note: Forbes Advisor may earn a commission on sales made from partner links on this page, but that doesn't affect our editors' opinions or evaluations.
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