Why does margin trading magnify the swings of my portfolio? That is a question we hear a lot from individuals who contact our law firm to determine if they have a valid claim against their brokerage firm or investment adviser to recover losses. When buying securities on margin, an investor borrows part of the funds needed to purchase the securities from his or her brokerage firm.
Just like a bank lends you money to purchase a home with a mortgage loan, a brokerage firm lends you money to invest against the value of securities in your portfolio. The securities in your margin account act as collateral for the loan. Margin trading has the effect of magnifying any profit or loss made on the investments.
While buying on margin carries a potential for greater reward because you are increasing your buying power, it also carries increased risk, including the potential to lose more money than was initially invested.
Just like any loan, when you buy securities on margin, you have to pay back the money you borrowed plus interest. So if the value of the securities in your portfolio declines, you haven’t just lost the amount of the decline, you must also pay back the borrowed money. The brokerage firm can force the sale of any securities in your margin account if the value falls below their margin requirements, even if it may result in completely wiping out your account and still leaving you with a loan to pay back.
As you can see, purchasing securities on margin can result in substantial losses. While some sophisticated investors with experience trading on margin understand the associated risks with this type of trading, some brokers who recommend this strategy are often less than upfront about the downside and the risks involved.
If you have lost money due to the misconduct of your account involving margin or if your broker traded in your account on margin without your permission or without properly explaining the risks of margin trading to you, you could have a claim against your broker or brokerage firm.
Contact one of our investment fraud attorneys today to discuss your potential case. Our initial consultations are free and all of our cases are handled on a contingency fee basis.