When investing in the stock market, you are given the option of opening a cash account or a trading margin account.  Many stock guru talks about how you can increase your stock income using margin account.  For the average stock investor, making used of margin accounts give them the power of leverage but it can also become the devils that causes the stocks investor to lose their shirts.

Differences between Cash and Margin Account

A cash account is one you pay for your stock purchases in full with cash. A trading margin account lets you buy stocks with borrowed money from the broker you are trading with. This comes at a cost, advantages, disadvantages and horrific consequences.

The advantage of buying stocks with margin is the leverage. Under current rules and regulations, investors can margin himself to 50%. This means a 2 to 1 leverage. For every dollar in upwards move of stock, you would double the profit.

Double Edged Sword

However, leverage can be a double-edged sword. For every dollar in downwards move of stock, your loss would be doubled too. Suppose you borrow 50% of the stock purchases and the stock price gets cut in half in a crash, you will contact with a fairly nasty message.

You will be asked to put up more cash into the account to carry the stocks. If you don't by the dateline, usually within 3 days, your account will be liquidated. The broker will sell your stocks in the open market to redeem his margin - money you borrowed him. This doesn't discount if several days later stock recover and starts to move back up again.

History of Trading Margin that Causes the Stock Market Downfall

During the roaring 20s, the margin requirement was very loose. Investors leveraged themselves to the hills. Some borrowed to 90% of stock value, much like today real estate speculation. The market was overheat and bubble was blown up under no financial strength of the company at all.

Everyone wanted to make quick bucks. When the market finally turned south, panic selling set. Most investors couldn't put up cash and margin calls echo all over in the market. And this ignited the Great Depression of the 1930s.

In conclusion, be careful when using trading margin account as it is a double edged sword, used it wrongly and it can hurts.

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