Yes, you can owe money on stocks if you buy stocks through a margin account because a margin account allows an investor to buy stocks on credit.
In a margin account, a brokerage, or investment bank, extends a line of credit, or margin, to an investor. The investor uses the credit line to buy stocks.
A classic margin account uses the stocks purchased as collateral for the credit line or margin loan. That means the investment banker or brokerage can sell the stocks if the margin loan is not repaid. If the stocks go up in price, the borrower uses part of the trading profits to pay off the loan.
The danger of a margin account is that the trader must repay the margin loan if the stocks lose value. Consequently, a trader can owe money on stocks.
Can you owe money in the stock market?
According to a poll, 10% of US stock trades use a margin account, meaning 10% of investors could owe money in the stock market because of margin trading.
If the share price falls below the amount borrowed to buy the stocks, owing money in the stock market is probable.
For example, a person who buys a $300 stock on the margin will owe $300 if the share price falls to $200 or $100. That borrower will lose $100 or $200 on the stock trade.
An investor can owe interest on margin trades. Margin interest rates can be between 3% and 12%, depending on the amounts borrowed. Investment banks give large-scale traders a lower rate. Brokerages and investment banks usually do not charge interest on futures margins because futures margins are not considered loans.
Margin account stock purchases are considered loans, however. That means margin traders can owe money in the stock market.
Many brokerages charge no commissions on margin trades because they make money from margin interest. Those brokerages encourage margin trading because margin interest is more profitable than commissions.
Can you end up owing money on stocks?
Anybody who uses a margin account can end up owing money on stocks. All it takes is a few losses. That means investors can owe margin debt on stocks. Investors need to watch the level of margin debt because it can lead to a margin call.
Can you go negative in stocks and owe money?
Any margin investor can see her account go negative and end up owing money. Investors need to be careful because going negative can lead to a margin call.
They issue a margin call when the funds in a margin account fall below the maintenance margin. The maintenance margin is the mandatory level of funds in the account.
Securities and Exchange Commission (SEC) regulations limit the initial amount of margin debt in a new margin account to 50% of the account balance. If margin debt rises over 50%, the institution issues a margin call.
Older accounts can have a lower maintenance margin. The typical maintenance margin for a US margin account is 25%. If an account has a 25% maintenance margin, the investor could face a margin call if 76% of the account is negative.
If the investor does not keep funds above the maintenance margin, the brokerage can sell the traders’ stocks or suspend the account. Traders need to be careful because any market loss can trigger a margin call.
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Can you owe money in penny stocks?
Yes, an investor could owe money on penny stocks if he or she bought them with a credit card or other lines of credit. Borrowing money to buy penny stocks is highly speculative and should be avoided because of the high level of risk.
A penny stock is low-quality equity that sells for a small price. The term penny stock comes from an earlier era when some stocks sold for a penny. However, today’s “penny stocks” usually sell for $1 to $5.
Most brokerages do not offer penny stocks because they are high-risk investments. Penny stocks can be risky because they sell most of them through the over-the-counter market. Over-the-counter means stocks are not sold through a big exchange – such as the NYSE.
Brokers consider penny stocks risky because many penny-stock companies do not have to file financial information with the Securities and Exchange Commission (SEC). That means there could be no prospectuses or financial information available about those companies.
Most brokerages and investment banks do not let investors buy penny stocks on the margin because of the risk. Thus it is hard to owe money on penny stocks.
Can you owe more money than you invest in stocks?
It is possible to owe more money than you invest in stocks if the funds in your margin account fall below the maintenance margin.
Investors can avoid this nightmare by calculating the maintenance margin requirement. You can calculate the maintenance margin requirement by subtracting the loan amount from the account value. If the result of that subtraction is over the maintenance margin, you owe money.
Investors need to watch the maintenance margin requirement to avoid margin calls. You need to watch the margin because margin calls must be immediately satisfied (paid). If you don’t pay the margin call, the brokerage can sell your stocks to cover it.
Owing money on stocks is possible, and owing money on stocks is probable if you buy stocks on the margin.
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