Margin CallThink telemarketer. Except, it's much worse because you can't avoid this call. Instead, when you get one, it's time to
pay up, because the bet you placed with borrowed money is eating itself.
Buying stocks on margin is risky because you're essentially "playing" with someone else's money. If the shares you purchased
tank, your losses will likely be more than if you had bought the shares with your own cash. This is why the New York Stock
Exchange and the Nasdaq impose certain restrictions on the practice.
Initially, you¿re only allowed to borrow half of the money from your broker when buying on margin. You set up a margin
account and from then on must keep a maintenance balance of at least 25% of the market value of your stocks.
If the market value of your investment falls below this minimum, you're required to make up the difference by either depositing
money into your account or selling some of the stock. If your broker notifies you that you've dipped below this minimum, it's
called a margin call.
If you fail to adjust your account accordingly, the broker is authorized to sell shares in your account to make up the
difference. The broker can even sell other stock in your margin account to make up for the loss that selling the shares didn't
cover.
As an example, say you buy $8,000 in stocks of any given company. You borrow the maximum $4,000 from your broker and pay
the rest yourself. Now, if and when the total value of these shares changes, you must make sure you maintain at least $2,000
(25%) in equity. In other words, if the total value were to drop below $6,000, you¿d be in trouble since you only put in $4,000
of your own money to begin with.
