"Buying stocks upon a margin," - a much used expression and a much abused custom. One of the dictionary meanings for "margin" is an edge or border, and from that has arisen its use in stock exchange transactions, originally meaning the difference between the actual amount of money paid for a given security and the amount which the broker is willing to furnish to his customer towards " carrying" it; but now used to describe the actual amount of money deposited by the purchaser with his broker. If he were to buy the stock outright and receive delivery of a certificate, a customer could buy only ten shares (par value $100) selling at par, but by going to a broker who does a "marginal business," so-called, he can largely increase the number of shares purchased. The broker would probably buy one share of stock for each $20 offered by the customer. A thousand dollars, therefore, would furnish sufficient margin for the purchase of fifty shares. The actual transaction in a legitimate broker's office is, that he purchases fifty shares of stock, we will say, at $100 a share; charging the client the regular commission for buying. The stock is delivered to the broker made out in his name, not in the client's, or "transferred in blank," and it is held as collateral security, so to speak, for the loan, which is really what it amounts to. It is understood that the customer will furnish more money in case of a market decline in the price, so that the difference of $20 per share between the market value of the stock and the amount loaned thereon to the client by the broker shall always be approximately maintained. If the stock declines five points, for example, the broker would naturally call upon the client for a further deposit of five dollars per share, or $250. If the money is not forthcoming, the broker would avail himself of his privilege of selling the stock before the margin was entirely exhausted. The transaction would be closed with the client, as follows:
Original cost of stock plus buying commission $5,007.50, selling stock at, say, 95, less selling commission of $7.50 - and transfer tax of $2.00, - $4,740.50. Loss in transaction, . $267, which would leave to be returned to the client out of his margin of $1,000 - $733, less also the amount of interest charged by the broker upon the money furnished during the transaction.
Had the stock advanced in price and been sold at a profit, there would have been no calling for a further deposit of cash from the customer, and all would have ended happily.
The idea of buying upon a "margin" is, that with a given amount of money a greater number of shares of stock can be purchased than as if bought outright; therefore, if the stock advances, there is a greater profit. The unfortunate side is, however, that if the stock declines the loss is also proportionately large.
This is one of the features of so-called stock speculation, and where it hits the hardest is on the part of persons who have not sufficient reserve capital to take up and pay for the stock in case of a decline, and when it might seem desirable to take the stock outright by paying the broker the entire amount of the loan, and thus wait for a more favourable time when it might, again, be sold at cost or possibly a profit. Take it when a stock has rapidly declined in price on account of some political unrest, or for a cause of lesser moment, when the decline is really no reflection whatsoever upon the intrinsic value of the security; it is in such cases where there is no reserve capital that "margins" are actually "wiped out," as the expression goes, and the speculator is perhaps seriously distressed.
There is "marginal buying" on the part of people of large means who are at any moment prepared to take up and pay for the securities in case of necessity, but whose money, perhaps, at the time of wishing to make a purchase in the stock market may be well and desirably invested in securities, which, in turn, are in the safe deposit box. The man of means, buying stocks at this time, very likely expects to buy for an anticipated quick rise in the stock market, and would make a "marginal" purchase temporarily rather than dispose of well-thought-of investments already owned. Such men, in case of necessity, can sell these securities and take up and pay for the stock " margined," or use them for increased "margins," and it is only this class of people who can safely carry stocks in this way.
It is the other sort of business which has been the cause of many stock exchange failures. When a brokerage house is carrying a large amount of securities for its customers on "margins," some sudden panic seizes the market and the stocks fall in value so quickly that it is impossible for the broker to sell before the "margins" are wiped out.1 For instance, supposing a large amount of stock is "margined" at 10%. Panic seizes the stock exchange and there is practically no chance to dispose of the stock before it has fallen, say, 20%. This rapid decline not only uses up the 10% deposited by the customers, but the broker has lost 10% unless he in turn can collect it from his clients. The inability to so collect, or to get his clients to put up further "margins," may result in disaster to the broker. In such cases as this the customer loses all the money he has deposited as a "margin." It must be remembered that the broker, in turn, is probably borrowing large sums to obtain sufficient funds to handle such quantities of stocks as a "marginal business" requires. The banks call upon the broker for more" margin; "the broker upon his clients; the clients cannot produce it; the broker in turn is unable and failure results. (See also " Bucket Shops.")
1 A broker selling out his customer must proceed with caution, first demanding more margin, and, if that is not forthcoming, being careful to give due oral or written notice before selling the securities. The law calls for a strict accounting in such proceedings.
A recent New York decision of the Court of Appeals has decided that a stock broker must give a customer formal notice of the time and place of the sale of stock held on " margin " for such client, or he cannot recover any loss which he may sustain in the transaction.
Whereas $20 is the amount of "margin "per share referred to above, and is probably the average amount required, the figure is a very movable one. Some brokers require a larger figure than others; stock selling around $200 would probably call for $40 per share; the usual intent being to maintain not less than 20% of the market value. Some stocks the better class of brokers would refuse to "margin" at all, and stock selling at a low figure, say around $20 per share, would be "half paid for" if "margined" at $10. That figure is obviously too high at such a time. Not only is the amount of "margin" demanded dependent upon the grade of the security, but its marketability. The privilege of calling for a greater "margin" is always reserved to the broker.
The charge made by brokers for carrying marginal accounts varies greatly, depending upon what interest they, in turn, have to pay on their own loans. Perhaps 5% to 8% is the average rate, but it depends very much upon the security. Naturally, taking an extreme case, 8% would ordinarily be too great a rate to charge for carrying government bonds. The rate depends upon whether the account is active or inactive. Where a man is trading from day to day and the broker is getting the benefit of the commissions, the inclination would be to charge a lesser rate of interest than on an inactive account, where a purchase or sale may not occur for a month at a time. In some instances accounts of people in not very good standing, or who deal in very speculative securities, 6 to 8 % may be the minimum. In any event the "carrying" charges, in the long run, are quite profitable to the broker, as he intends to charge about 1% more to his customer than he, in turn, has to pay for the accommodation. In the event of higher money rates, he naturally advances the rate to the customer. Most stock exchanges do not allow the charging of a lesser rate than the average which the broker himself is obliged to pay on all his loans. As an offset to the carrying charges the customer is always credited with dividends declared or interest paid upon the securities purchased. The rules of the London Stock Exchange do not permit of dealings on " margin."