Dominick,
In a cash account, you can deposit any combination of stocks, cash or other equity/debt instruments, and even if you're the world's lousiest investor, you're absolutely guaranteed that you cannot lose anything more than what you deposited. Absolute worst case, your account goes to zero and the broker eventually closes it for inactivity.
However, a margin account is sort of like the overdraft portion of a checking account. That is to say, you can exceed your balance and go negative, or spend more than what you have.
In an established short position, there is no guarantee that you can cover the short position before you go into the red. Even if you use stops, stocks can and do gap past stop points. So the brokerage has to have some sort of protection in the event your account goes into the red. And that protection is the margin agreement. That is why short transactions must be from a margin account.
Many people think that the reason is that if you're going to short someone's long position with a borrow (say MSFT), then they should have the opportunity to short your long position (say DELL). After all, turn about is fair play, right? And besides that, if everyone kept their long positions in a cash account, then there would be no borrows available for shorting. The fallacy of this argument is, of course, that you can have more than one account, use more than one brokerage, etc. thereby shielding your long positions in a cash account, and doing your shorting activities in a margin account.
Hope this helps.
KJC |
