The difference between using
cash and using margin:
If you invest in stocks just with the money you have in your brokerage account, you are using a cash account
If you borrow money from the brokerage to invest in stocks, you are using a margin account -- you do not pay in full for stocks that you buy or sell.
The collateral for borrowing the money is the marginable securities in your account, which means they are forfeit if you cannot pay the loan
You also have to pay a fixed amount of interest on the borrowed money on a monthly basis, which can reduce your overall returns
The risks associated with margin trading are also increased by leverage -- you lose twice as fast because there is less money backing the position.
I know, this sounds VERY risky. And it is. But here are some reasons why you would want to use margin:
To try to double your returns (or to double your losses)
The worst case scenario is when a stock price drops so much that it causes a "margin call," which means you either add more money to the account or you automatically get sold out of the position at a loss
Remember, higher risk is how higher return comes about. You can take your chances on things working out and getting a huge return, or things not working out and you take a huge loss.
How to find out which stocks are marginable:
As a general rule, stocks selling below $5 are rarely marginable
Government regulations and brokerages dictate which stocks are marginable, so you may want to ask your broker for help here.
The skinny on initial and maintenance margin requirements:
The amount that you can borrow is regulated by the brokerage as well as the Federal Reserve Board
1. How much margin you can initially use
There are two requirements to this:
2. How much margin you can have after you make the initial transaction.