What is leveraging?
When buying stocks on margin, you are employing leverage as an investing strategy. Leverage allows you to extend your financial reach by investing using borrowed funds in addition to your own cash. Please note, however, that this can involve a high degree of risk, as investors may lose more than they invest. In the case of margin trading, investors generally use a leverage strategy to buy securities (on margin) in the hopes of enhancing their investment returns, but margin can also magnify losses.
How can an investor mitigate some of the risk in margin trading?
Purchasing, or borrowing against, securities on margin always carries a degree of risk. You can help manage that risk by:
- Limiting your use of leverage by not using your entire margin balance
- Diversifying your investment portfolio
- Borrowing against more stable securities
- Using margin for short-term investments
You should monitor the market and your investments against your risk tolerance and target goals.
Diversification does not ensure a profit or protect against loss in declining markets.
What is a margin call?
This is a generic term that refers to both maintenance calls and Regulation T calls (also referred to as Reg T or Fed calls). When the securities in your margin account decline in value, so does the value of the collateral supporting your loan. If the value of the securities declines enough, your brokerage firm may issue a margin call.
An investor who receives a margin call is required to deposit additional funds or securities in a margin account because the equity in the account doesn’t meet the brokerage firm’s established minimum equity requirement (maintenance call or “house margin”). This could be due to changes in the market value of the margined securities, or because additional securities have been purchased or sold short in your margin account.
What is a Regulation T call?
This is the amount that an investor must deposit if buying on margin or selling short, as required by the Federal Reserve Board’s Regulation T. The Federal Reserve currently requires that the investor put up 50% of the cost of the security being traded. As is true of most firms, Wells Fargo Advisors reserves the right to impose higher or special maintenance requirements, depending on the volatility of the specific securities.
What is a maintenance call?
This is a call for additional funds or acceptable collateral that must be immediately deposited into your margin account, and occurs when the equity in your margin account does not meet the broker-dealer’s established minimum requirement. It may be due to fluctuations in the market or your additional use of margin. All margin accounts are regulated by the Federal Reserve and FINRA as well as Wells Fargo or Wells Fargo Advisors’ internal policies.
A brokerage firm generally issues a maintenance call when the equity in your margin account falls below ”house margin requirement,” typically about 30% or 40% of the total amount borrowed. If you do not deposit enough money – either in cash or securities – in time to meet the call, your brokerage firm may sell securities in your account in order to cover the house margin requirement. Wells Fargo Advisors also reserves right to increase maintenance requirements, which could trigger a call. Please realize that you will not get an extension of time to meet a call, and the firm is not required to contact you before executing the sale.
How do you avoid a margin call?
As a margin user, you need to thoroughly understand the risks associated with using this kind of leverage in your brokerage account, especially when you borrow at or near the initial margin limit.
- Give yourself a buffer. Make sure you don’t use all of your available funds in your margin account.
- Monitor your account. If you notice the value of stocks in your margin account are declining, deposit additional funds or collateral.
- Be prepared for margin calls. Keep a reserve of funds available outside your brokerage account so that you can quickly meet a margin call.
What is a Special Memorandum Account (SMA)?
The Federal Reserve authorizes this special account to preserve buying power in your margin account. It reflects any excess equity in your margin account that is above the required amount (50% for marginable securities).
What are margin eligible securities?
Most securities are eligible to be used as collateral including most equities, other than low priced or thinly traded stocks, most mutual funds, if you’ve held the mutual funds for a minimum of 30 days, and most investment grade fixed income securities (municipal, corporate, government agency or Treasury bonds).
What securities are not margin eligible?
Some assets are not available to use as collateral for margin borrowing, including money market funds, precious metals, annuities, and offshore mutual funds.
Can margin trading be used in my qualified retirement accounts?
No. Because of the inherent risks in margining securities and regulatory prohibitions against doing so, margin is not permitted in retirement accounts.
Why set up a margin account with Wells Fargo Advisors?
- Competitive interest rates
- 24/7 Online access to information: margin loan balance, margin buying power, funds available to withdraw, and margin activity information
- Convenient margin trading: place trades online, through our automated telephone system or speak with one of our investment professionals
- Easy withdrawal of funds, including online transfers between linked brokerage and Wells Fargo bank accounts. You can also use margin loans against securities held in your brokerage account for a wide variety of business or personal needs.