Understanding Margin Debt

Margin debt refers to the amount of securities held in a portfolio or group of portfolios that have been purchased on margin. Margin is a way of saying "with a loan" in the stock brokerage industry. When an investor has an account with a brokerage, that investor is free to purchase with a loan from the broker; however, the broker will impose limits. An account cannot continue to fall deeper into margin debt, or a margin call will occur. 

Margin Debt of Individual Account

An individual typically must have a minimum account balance in order to be permitted to purchase on margin. This amount varies with brokers. Some brokers of more sophisticated securities may require an account holder have excess  of $100,000 in order to purchase on margin. In other cases, a broker may extend the option to any individual with a simple $1,000 invested. The key is, however, to keep the margin debt low in comparison to the total account balance. If a $100,000 account holder has $70,000 of margin debt, then this individual is operating at 70 percent debt. This would not typically be permitted at any brokerage.

Margin Debt and Margin Calls

When an individual does rack up a large amount of margin debt, the total margin ratio of his account may drop below the minimum margin requirement. This means the brokerage could make a margin call. A margin call requires the investor to make up the additional money needed in the account by one of two ways: the account holder can sell some of the securities purchased on margin to repay the lender; or, the investor can add additional funds to the account. Typically, a broker will require a relatively low margin debt compared to the amount of money in the account. It is rare to permit any sum larger than 50 percent of the account balance. Remember: if the value of the underlying securities purchased on margin rises, the margin debt also rises.

Margin Debt of a Group

Margin debt can also be used to estimate market trends. When a group of investors is operating at a very low margin debt, that group is likely skeptical of the future of the market. They do not want to borrow new money to purchase securities for fear the securities will lose value. On the other hand, when investors feel securities will rise sharply in the near future, they are likely to use as much margin debt as possible. By watching the margin debt of all accounts held with a brokerage, then, an investor can see the general attitude its account holders have toward the prospects of the market.

Margin Debt of a Country

This measure of optimism is also applied to countries as a whole. For example, US investors are likely to stop buying on margin after a stock market crash. However, if the market begins to show signs of recovery, the investors would start purchasing with loaned dollars once again. Therefore, economists often evaluate the entire margin debt of country in order to gain information about the attitudes its citizens have toward the future of the securities market.

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