Margin Trading and Its Risks
Margin trading, also known as buying on margin, can be a risky proposition even with its potential for higher returns. This is why it is important that before you engage in this kind of investing strategy your broker fully apprises you of all the risks. It is also essential that if margin trading is too risky for you given your risk tolerance level, financial goals, investing inexperience, or age, your financial advisor strongly suggests that you refrain from this approach.
Unfortunately, due to the high commissions and other fees that margin trading can render for brokerage firms, there are those that have continued to unsuitably recommend this investing strategy to many customers, including to unsophisticated or conservative investors. Not only is this a violation of these customers’ best interests, but also it may be grounds for filing a Financial Industry Regulatory Authority (FINRA) arbitration claim against the firm so that the investor can pursue damages for their losses with a securities lawyer.
At Shepherd Smith Edwards and Kantas (investorlawyers.com) our skilled margin trading losses attorneys have represented thousands of investors, including retail customers, retirees, and high-net-worth individual investors, against broker-dealers in FINRA arbitration, mediation, and litigation. Our securities attorneys have recovered many millions of dollars for our clients.How Margin Trading Works and Why It Can Be So Risky
With this investing strategy, you are essentially “buying on margin,” meaning you are borrowing funds from your broker-dealer and using the money to purchase stocks. You are taking out a loan from the firm that you will pay back, usually with interest, later on. Meanwhile, the securities in your margin account serve as collateral.
While a margin account can enhance your buying power — having the higher financial leverage allows you to invest more and potentially magnify your earnings — it may also increase your losses. Not only that, but as an investor with a margin account, the interest on your loan immediately begins to accrue, which immediately causes your debt level to grow.
The longer you hold the investment that you acquired through margin trading, the more of a return you need to make to break even. This means that holding an investment on margin for a very long time decreases the odds that you will make a profit.
Also, many investors who have traded on margin may not realize that even a temporary decline in a stock’s value can result in liquidation, which may lead to huge losses.
Meanwhile, margin brokerage accounts can be highly profitable for broker-dealers as they can earn even more on margin interests than with the hefty commissions they are already charging. Also, some financial firms may pay their brokers an added bonus when they can charge their clients for holding margin accounts.What are the Perils of the Margin Call?
At some point, as a margin trading investor, you may have to deal with a margin call. This is what happens when your brokerage firm requires you to deposit more money into your margin account because the value of the securities you are holding has experienced a decrease in equity.
In the event that you cannot provide this additional equity or that if your margin account’s value declines so quickly that it can no longer meet your brokerage firm’s margin requirements, you may be subject to forced liquidation. When this happens you could end up having to sell the securities you bought on margin to fulfill these requirements, which could lead to you also losing money.What are Some Signs That Your Margin Trading Losses May Be Due to Broker Misconduct or Negligence?
- You are an inexperienced investor who has a low-risk tolerance level yet your financial advisor unsuitably recommended that you set up a margin account.
- Your brokerage firm failed to fully apprise you of the nature of margin trading and neglected to make sure you understood all of the risks.
- Your broker engaged in margin trading on your behalf without getting your permission.
- Your financial advisor mismanaged your margin account.
The circumstances surrounding your margin trading losses will be unique to you, which is why you need to work with a seasoned securities lawyer and investment fraud law firm that has the skills, experience, and resources to file a solid FINRA arbitration claim against the broker-dealer on your behalf.
With over a century’s worth of combined experience in the securities industry and securities law, Shepherd Smith Edwards and Kantas’ securities attorneys may be able to help. Call us at (800) 259-9010 or contact us online to request your free, no-obligation case consultation.