A margin account has virtually no restrictions and allows trading of any asset. The primary benefit is the ability to borrow additional funds from your brokerage, which then lets you take on more positions than your cash balance would allow.
That borrowing power cuts both ways: it can amplify gains, but it can also amplify losses. And if your account borrows too much relative to the value of your holdings, the brokerage may issue a “margin call” and require you to return some of the borrowed funds.
A margin account also allows you to engage in shorting strategies for equity, ETF, and option positions.
No contribution limits
Like a cash account, a margin account is a non-registered account that has no contribution limit. Unless you're looking to short securities or hold otherwise restricted investments, this account is typically opened only after registered accounts have been maxed out.
Borrowing on margin
When you make a purchase in a margin account, your own cash is used first. This is to avoid unnecessary interest charges.
Once your cash is depleted, any additional purchases draw on funds from the brokerage. A useful way to tell if you're borrowing: check whether your Canadian cash or US cash is showing as negative.
Any negative cash balances held overnight will start accumulating interest. Rates vary by brokerage and can usually be found on their website.
How the math works
Every position in a margin account has a margin requirement, which is how much you need to supply from your own funds. For long positions, this typically ranges from 20% to 100%. For short positions, it could be as high as 500%. Requirements vary by security and can usually be found on your trading platform – and the brokerage can also change them at any time.
For example: if you have $2,000 of your own cash in your account and want to buy a security with a 40% margin requirement, you could buy up to $5,000 worth. You'd supply $2,000 (40%) and the brokerage would cover the remaining $3,000 (60%).
Borrowing too much can trigger a margin call
Your brokerage will always display how much margin you have available. This figure must remain positive at all times. If it goes negative, it means you're no longer supplying enough of your own funds to meet the margin requirements of your holdings, and the brokerage will issue a margin call.
Available margin is a running calculation that updates continuously based on price fluctuations. The brokerage will calculate this automatically, but to calculate it manually, the formula is:
Total equity - total margin requirements of all current positions
There are two ways a margin account can fall into a margin call even without making new purchases:
- The value of the holdings drops, lowering your total equity.
- The brokerage raises the margin requirements on one or more of your securities. This can happen after a purchase has already been made, if the brokerage decides to reduce its own risk.
Fixing a margin call
A margin call signals that the brokerage is concerned that the funds it lent may be at risk. Each situation is different, but in most cases the brokerage will give you a deadline to resolve it in one of two ways:
- Depositing additional funds into the account, which raises your total equity.
- Closing some existing positions, which lowers your total margin requirements.
Acting quickly matters. At any time, the brokerage can close positions in your account without notice. This is outlined in the margin account agreement you sign when opening the account.
To reduce the risk of margin calls from normal daily price fluctuations, avoid using the full amount of available margin.
Tax implications
As a non-registered account, a margin account comes with additional tax considerations each year. The most common are taxes on income generated in the account (dividends or interest) and taxes on capital gains. For capital gains, only positions closed during the year need to be reported.
Most brokers provide the tax documents you'll need at year end, though these tax slips can be inaccurate for a variety of reasons. It's always a good idea to keep your own records of all transactions and consult a tax specialist to make sure you're filing correctly.
Summary
A margin account lets you borrow money from your brokerage to increase your purchasing power. The brokerage monitors the account continuously to ensure sufficient margin is maintained. If holdings drop in value or margin requirements change, the brokerage may issue a margin call, giving you a deadline to either deposit funds or close positions. If you don't act, the brokerage can close positions on your behalf. There's no contribution limit, but a margin account does require additional tax filing each year.
