How securities are traded: orders, margin, accounts and taxes

Lesson 1 described where securities trade. This lesson follows a trade from the investor's side: the kinds of orders that can be placed, what trading really costs, how investors borrow to buy (buying on margin) or sell shares they do not own (short selling), and which accounts and tax rules shape the return an investor actually keeps. These details look mechanical, but they matter. Costs, leverage and taxes can turn a good investment into a poor one, and the account an asset is held in can be worth as much as the choice of asset itself. The rules described here were checked in October 2026; contribution limits and tax thresholds change every year, so investors should confirm current figures with the tax authority.

Types of orders

A market order asks the broker to buy or sell immediately at the best available price. It guarantees execution but not price: in a fast-moving or thinly traded stock the investor may pay much more than the last quoted price. A limit order sets the worst acceptable price, a maximum for a buy or a minimum for a sell, and waits in the order book until it can be filled at that price or better. It guarantees price but not execution. A stop order, or stop-loss, becomes a market order once the stock trades at or through a trigger price; it is used to limit losses or protect gains, but in a sharp drop the sale may happen far below the stop. A stop-limit order becomes a limit order at the trigger, so it protects price but may not be filled at all. Orders can also specify how long they last, such as for the day or until canceled.

Every stock has a bid, the highest price a buyer is offering, and an ask, the lowest price a seller will accept. The difference is the bid–ask spread. A buyer using a market order pays the ask; a seller receives the bid; an investor who buys and immediately sells loses the spread. For large, heavily traded shares the spread may be a cent; for small companies, exchange-traded funds with little trading, or bonds, it can be much wider. Large orders also move the price against the trader, a cost called market impact. Explicit costs, such as commissions, have fallen to zero at many online brokers, but the spread and market impact remain, and some zero-commission brokers are paid by market makers for routing orders to them, a practice called payment for order flow that regulators continue to scrutinize.

Buying on margin

A margin account lets an investor borrow from the broker to buy securities, using the securities as collateral. The investor's equity is the market value of the securities minus the loan. The initial margin is the minimum fraction of the purchase the investor must pay in cash; the maintenance margin is the minimum equity, as a fraction of market value, that must be kept. If prices fall and equity drops below the maintenance level, the broker issues a margin call: the investor must deposit cash or securities, or the broker sells positions, often at the worst moment. Interest is charged on the loan, usually at a rate well above the risk-free rate.

In the United States, the Federal Reserve's Regulation T sets the initial margin for most listed shares at 50 %, and FINRA requires maintenance equity of at least 25 %. Brokers commonly set higher house requirements, often 30 % or more, and higher still for volatile shares.

Margin magnifies returns in both directions, exactly like the financial leverage in FIN-201 lesson 12. With half the purchase borrowed, a 10 % rise in the stock gives roughly a 20 % return on the investor's equity before interest, and a 10 % fall a 20 % loss. The price at which a margin call occurs can be found from the condition that equity equals the maintenance fraction of market value.

Here \( n \) is the number of shares, \( D \) the loan, \( m \) the maintenance margin and \( P^{*} \) the price that triggers a call.

Short selling

A short sale profits from a price decline. The investor borrows shares from the broker, sells them, and later buys them back to return to the lender. The profit is the sale price minus the repurchase price, minus any dividends paid to the lender while the shares are borrowed and any borrowing fee. Short sellers must post margin, keeping the sale proceeds plus additional equity in the account. Because a share price can rise without limit, a short seller's potential loss is unlimited, and a sharp rise can force many short sellers to buy at once, a short squeeze such as the one in GameStop shares in January 2021. Short sellers are often unpopular, but they help keep prices honest: some of the best-known accounting frauds were exposed by short sellers who had studied a company's accounts closely.

# Margin purchase and short sale, one-year horizon
def margin_return(n, p0, p1, init_margin, rate, div=0.0):
    equity0 = n * p0 * init_margin
    loan = n * p0 - equity0
    equity1 = n * p1 + n * div - loan * (1 + rate)
    return equity1 / equity0 - 1

def call_price_long(n, loan, maint):
    return loan / (n * (1 - maint))

def short_result(n, p0, p1, deposit, div=0.0):
    profit = n * (p0 - p1) - n * div
    return profit, profit / deposit

def call_price_short(n, p0, deposit, maint):
    # equity = deposit + proceeds - n*P ; call when equity / (n*P) = maint
    return (deposit + n * p0) / (n * (1 + maint))

for p1 in (60, 50, 40):
    print(f"long on margin, price {p1}: return {margin_return(1000, 50, p1, 0.5, 0.06):+.1%}")
print(f"margin call below {call_price_long(1000, 25_000, 0.30):.2f}")

for p1 in (70, 80, 90):
    prof, r = short_result(500, 80, p1, deposit=20_000, div=1.0)
    print(f"short 500 at 80, cover at {p1}: profit {prof:+,.0f}, return on deposit {r:+.1%}")
print(f"short margin call above {call_price_short(500, 80, 20_000, 0.30):.2f}")

long on margin, price 60: return +34.0%
long on margin, price 50: return -6.0%
long on margin, price 40: return -46.0%
margin call below 35.71
short 500 at 80, cover at 70: profit +4,500, return on deposit +22.5%
short 500 at 80, cover at 80: profit -500, return on deposit -2.5%
short 500 at 80, cover at 90: profit -5,500, return on deposit -27.5%
short margin call above 92.31

Tax-advantaged accounts

The United States offers several tax-advantaged accounts. In a traditional 401(k), contributions reduce taxable income, growth is tax-deferred, and withdrawals are taxed as income; the 2026 employee deferral limit is $24,500, plus an $8,000 catch-up from age 50 and a higher $11,250 catch-up at ages 60 to 63, and many employers add matching contributions. Roth 401(k) contributions are made after tax, but qualified withdrawals are tax-free. Individual retirement accounts (IRAs) allow $7,500 in 2026, plus $1,100 from age 50; Roth IRA contributions phase out for single filers with modified adjusted gross income between $153,000 and $168,000. Health savings accounts and 529 education plans offer further tax advantages for specific purposes.

The two broad designs, tax deferral (deduct now, tax on withdrawal) and tax-free growth (no deduction, no tax on withdrawal), give the same after-tax result when the tax rate on contribution equals the rate on withdrawal. The deferral account wins when the investor's tax rate in retirement will be lower than today; the tax-free account wins when it will be higher, or when withdrawals might reduce income-tested benefits. Both beat an ordinary taxable account, because they shelter the investment return from tax every year.

Taxes on investment income

In a taxable US account, interest is taxed as ordinary income. Gains on assets held more than a year are long-term capital gains, taxed at 0 %, 15 % or 20 % depending on taxable income; for 2026 the 15 % rate starts above $49,450 for single filers ($98,900 for married couples filing jointly) and the 20 % rate above $545,500 ($613,700). Qualified dividends receive the same rates, while short-term gains and non-qualified dividends are taxed as ordinary income. A 3.8 % net investment income tax applies above $200,000 of modified adjusted gross income for single filers ($250,000 joint). Capital losses offset gains, plus up to $3,000 of ordinary income a year, but the wash sale rule disallows a loss if substantially identical securities are bought within 30 days before or after the sale, including in an IRA.

Taxes change the best place to hold each asset, a decision called asset location. Because interest is taxed most heavily, bonds are often better held inside a sheltered account and shares, whose returns come partly as lightly taxed gains and dividends, in a taxable account. The right answer depends on the investor's tax rates, expected returns and need for access to the money, so the rule of thumb is a starting point rather than a law.