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Stock Market

Margin and leverage

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Margin and leverage

Margin is borrowed money used to purchase securities, allowing investors to buy more shares than their cash alone permits. A margin account lets you borrow up to 50% of a security's purchase price under Regulation T (Reg T)—meaning you can buy $200 worth of stock with $100 cash. This leverage amplifies returns: if you buy $200 of stock with $100 cash and the stock appreciates 10%, your $100 investment grows to $120 (a 20% return). But leverage cuts both ways: if the stock declines 10%, your $100 becomes $80 (a 20% loss). Margin accounts are powerful tools for experienced investors but dangerous for those who don't fully understand the mechanics. Most retail investors should avoid margin or use it conservatively until they deeply understand how it works.

The regulatory framework around margin exists to prevent investors from destroying themselves and to protect brokers from counterparty defaults. Reg T requires 50% initial margin for stocks—you need at least 50% cash to buy a $1,000 position. Once you own the position, maintenance margin (typically 25-30%) requires you to maintain that percentage in equity. If your account equity drops below maintenance—a margin call occurs—your broker demands immediate payment or forced liquidation of positions. The mathematics of margin calls are brutal: a 33% stock decline when you're at 2:1 leverage wipes out your entire account. Many retail investors who start with margin accounts end up at leverage levels they didn't intend, not realizing how market volatility interacts with maintenance requirements.

Understanding margin is critical to risk management. Margin amplifies both gains and losses symmetrically—a 10% gain becomes 20%, and a 10% loss becomes -20%. But the risk profile isn't symmetric: unlimited downside loss potential exists while upside is theoretically unlimited. Most professional traders use margin strategically for specific positions, maintaining careful position sizing and stop-loss disciplines. Retail investors often use margin impulsively without understanding the risks, leading to forced liquidations at the worst possible times—selling winners to raise cash for margin calls, crystallizing losses. Learning margin mechanics through a small position first (rather than full leverage) is the safest approach. Understanding the mathematics of drawdown—how a 20% loss requires a 25% gain to recover—reveals why leverage is more dangerous than the percentage gains and losses suggest.

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