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Textbook
1. Introduction
2. Common stock
3. Preferred stock
4. Debt securities
5. Corporate debt
6. Municipal debt
7. US government debt
8. Investment companies
9. Alternative pooled investments
10. Options
11. Taxes
12. The primary market
13. The secondary market
14. Brokerage accounts
14.1 Fundamentals
14.2 New accounts
14.3 Account registrations
14.4 Margin accounts
14.4.1 Overview
14.4.2 Opening a margin account
14.4.3 Deposit requirements
14.4.4 Equity
14.4.5 Minimum maintenance
14.5 Options accounts
14.6 Other account specifications
15. Retirement & education plans
16. Rules & ethics
17. Wrapping up
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14.4.1 Overview
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14. Brokerage accounts
14.4. Margin accounts

Overview

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At brokerage firms, there are two main types of accounts: cash and margin accounts. Cash accounts require customers to pay 100% for each security transaction and prohibit strategies that involve unlimited loss potential like short selling securities. Margin accounts allow customers to borrow money for investment purposes and allow risky strategies. In fact, margin accounts are required for short sales and any other strategy involving unlimited risk (like short calls).

When a customer borrows money for investment purposes, they leverage themselves. Leverage involves amplified gains and losses. Customers utilizing margin accounts are able to make more money when they make the right investments, but also are subject to more losses when the market moves against them.

Imagine you have $5,000 of your own money and borrow another $5,000 from a friend. Then, you take all $10,000 to the casino and bet it all on one game. If you win, you double your money to $20,000, which would make you more money than if you only had your $5,000. If you lose, you not only lose your $5,000, but also your friend’s $5,000 that you owe back to them.

Borrowing money for gambling works the same way as investing. Investors make more money if they make the right investment, but could lose more if they’re wrong. There’s a fair amount of risk involved with margin accounts, which is why they’re only suitable for risk-tolerant investors that can withstand losing significant amounts of money.

In this chapter, we’ll discuss how margin accounts work, the regulations that govern them, and how customers utilize them.

Key points

Margin accounts

  • Borrow money for investment (leverage)
  • Only suitable for risk-tolerant investors

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