Collateral

Collateral is something of value you pledge to a lender or broker as a backstop for money or securities they've lent you. If you can't repay or cover what you owe, the lender has the right to seize or sell the collateral to make itself whole.

In trading, the most common form of collateral is the cash and securities sitting in your brokerage account. When you open a margin account and borrow money from your broker to buy more stock than your cash alone would allow, the stocks you already hold — along with your cash — serve as collateral for that loan. The broker doesn't take physical possession of anything; it just has a claim on those assets and can sell them without asking if things move against you.

The nuance that trips people up is that collateral value isn't fixed. It's usually a percentage of the current market value of the assets, so as prices fall, the amount of collateral you have falls too, even though you haven't sold anything or done anything wrong. This is exactly what triggers a margin call: your collateral has shrunk relative to what you owe, and the broker demands you add more cash or securities, or it will sell positions itself to cover the gap.

It also matters that not all assets make equally good collateral. Cash is the cleanest. Highly liquid, large-cap stocks are usually accepted at a high percentage of their value. Volatile, thinly traded, or low-priced stocks are often given little or no collateral value at all, because the broker can't be confident it could sell them quickly at a fair price if it needed to.