Margin is a term that has many meanings in the financial world. A profit margin is a measure of how much money a company is making. In the world of futures trading, margin is a deposit that an investor puts down in order to enter a position. Meanwhile, in stock trading, margin is money borrowed from a broker. Beware before taking out one of these loans, however, as money borrowed in margin accounts will incur interest charges.
Types of Margin
Margin in the futures market is a lot different from margin in equities trading. In futures trading, margin is a deposit made with the broker in order to open a position. The amount is a fixed percentage—usually between 3% and 12%—of the notional value of the contract. There are no interest charges to the customer on futures margin because it is not a loan.
- Margin can have different meanings in the world of investing: profit margin, futures margin, and equities margin.
- There are no interest charges on futures margin because it represents a deposit held with the broker to open a contract.
- Investors can borrow up to 50% of the value of equities in a margin account held at a stock brokerage and will pay interest charges for the privilege of doing so.
- Interest charges vary by broker but are typically a function of prevailing interest rates and the term of the loan.
Trading stocks on margin is a different story. Investors can borrow up to 50% of the value of their stock holdings when buying with margin. The loan allows for the purchases of additional securities or, in some cases, the withdrawal of money from the account for short-term financial needs. Each brokerage firm will decide which types of investments are marginable and the list often includes stocks that trade for more than $5 per share.
Calculating Interest Charges
Brokerages charge interest on margin loans and the revenues from the activity is one reason that firms can offer low—even zero—commissions on trades to their customers. Since the calculation of margin can vary, you should speak to your broker directly, if you cannot find the information on their website. As a general rule, the formula takes the annualized interest rate, multiplies by the amount borrowed, and also multiplies by the time frame of the margin loan:
Interest=(365Rate)×Principal×Termwhere:Rate=Interest rate per yearPrincipal=Amount borrowedTerm=Number of days borrowing
The easiest way to find out how much you have borrowed is to take the equity in your account and subtract it by the market value. If you have a negative amount, this will be the amount you owe. If the difference is zero, then you owe nothing, and if it is positive, you have cash that you can invest somewhere else or take out of the margin account, which generally doesn’t pay much interest.
Once again, this is a general approach and does not necessarily reflect the policy of all brokerages. If you want to find out the exact calculations, check their website and, if that fails, give them a call.