Buying on margin allows investors to buy more than they otherwise could have. For example, if Marshall Twitchlee thought that stock ABC was a good buy and he had $1000 to spend, if he bought on a 50% margin then he could buy $2000 worth of ABC stock instead of just $1000. This has a tendency to push the market up. Imagine one million "Marshall's" being able to double the amount of money they were willing to invest in the stock market.

In the 1920s you could buy $100,000 worth of stock with 10% margin ($10,000), borrowing the remaining 90%($90,000) from your broker.  Each day the value of you holding is markeed market to market to ensure that minimum margin is maintained.  If the price of the stock falls by 5%, the value of the stock decreases by $5,000.  But you still owe $90,000.  The value of your position, sometimes called your equity, has decreased 50%, from $10,000 to $5,000.  The process of figuring out how much equity you have in your account is called marking it to market.  A large percentage decline in your equity triggers a margin call from your broker.

CONTEMPORARY CONNECTIONS - Margin Buying Today

Following the crash, the Federal Reserve enacted Regulation T which provides that your broker can only lend you at most half of the money needed to buy a stock.

Here is an example on the present rules provided by the National Association of Securities Dealers: 

If you buy $100,000 of stock with a 50% margin, you will pay $50,000 for the stock and borrow the remaining $50,000 from your broker.  Your equity in the account is $50,000 and you receive a margin loan of $50,000 from the broker.  You pay 50% and your Broker pays 50% Assume that later, the value of the securities falls from $100,000 to $60,000.  How does this change the situation?  The loan remains the same amount, $50,000.  However, your equity decreases to $10,000 ($60,000 market value minus $50,000, loan amount).  The law requires a minimum maintenance margin of 25%.  In this hypothetical, this means that your equity must not fall below $15,000 ($60,000 market value multiplied by 25%).  Since the required equity is $15,000, you would have to pay a margin call of $5,000 ($15,000 minimum required equity minus existing equity of $10,000). 

 

http://www.aboutbrokerfraud.com/2007/05/did_margin_caus.html

CONTEMPORARY CONNECTIONS - Margin Buying Today

Margin means buying securities, such as stocks, by using funds you borrow from your broker. Buying stock on margin is similar to buying a house with a mortgage.  If you buy a house at a purchase price of $100,000 and put 10 percent down, your equity (the part you own) is $10,000, and you borrow the remaining $90,000 with a mortgage.

If the value of the house rises to $120,000 and you sell, you will make a profit of 100 percent (closing costs excluded). How is that? The $20,000 gain on the property represents a gain of 20 percent on the purchase price of $100,000, but because your real investment is $10,000 (the down payment), your gain works out to 200 percent (a gain of $20,000 on your initial investment of $10,000).