What are Margin Requirements?

Malcolm Tatum

Margin requirements have to do with the amount of funds that an investor must have in a margin account before being able to purchase investments on a credit or margin basis. The main function of these types of requirements is to prevent an investor from incurring a level of debt that he or she would not be able to repay. In the United States, the regulations that govern margin requirements are set by the Federal Reserve Board. Many other countries also have regulations in place that make it necessary to deposit funds into a margin account before an investor can trade on a margin or even sell short on a stock issue.

The U.S. Federal Reserve Board sets standards for margin requirements.
The U.S. Federal Reserve Board sets standards for margin requirements.

While margin requirements in force around the world vary somewhat from one country to the next, many nations do create standards that are very similar to those upheld by the Federal Reserve Board and the New York Stock Exchange. For example, the regulations often allow the investor to borrow no more than half of the price of acquiring a new position as part of a stock purchase. This means that if the investment would cost a total of $300,000 in United States Dollars (USD), the investor would need to deposit a minimum of $150,000 USD in a margin account. Assuming that the investment is a good one that begins to generate a return quickly, there is a good chance the investor can retire the debt quickly, and be free to use the balance of the margin account for another stock transaction.

For open positions such as futures contracts or some type of short sale transactions, it is not unusual for the margin requirements to demand a percentage of the total purchase price in order to allow the investor to buy on margin. For example, for a long position, the investor would need to maintain a minimum of a 25% equity in the account, or a 30% equity for a short position. If the investment performs as projected, the investor is able to avoid a margin call, which many brokerages will make if the long or short position acquired by buying on margin sinks below a certain amount of the original purchase price.

It is important to note that the margin requirements that are put in place by regulatory agencies and even various stock markets only constitute the minimum requirements that an investor must meet in order to trade on margin. This means that a brokerage can and often does set its own requirements that are even more stringent than those set in place by law. Doing so not only helps to protect the investor, but also prevents the brokerage from encountering a great deal of inconvenience if a client is unable to honor his or her financial obligations.

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