Margin - Trading Strategies | NYSE | NASDAQ

Margin Trading

Using Margin
By Larry Potter

Margin

We realize that as the market improves more people will use margin and borrow from their brokers. Margin increases their buying power and when all is right with the world it literally doubles profit potential. But if they make a lousy play, they have to pay back double. That’s why we have preached for years against using margin. There’s already enough risk in the market.

Let’s suppose you like XYZ at 50 and wanted to buy a bunch of it, but you didn't have the cash. So you decide to “margin” it, which simply means you borrowed 50% of the money to buy XYZ from your brokerage. If the trade goes well and XYZ moves higher, you can sell with a very nice profit.

But what if the market is in the process of correcting as it has in recent days? Old XYZ could take a 10-15 point loss, and there is a good chance that eventually the brokerage will call you for the balance. Well, if you had to borrow the money to buy XYZ in the first place, where are you going to get the money to pay back the broker? We know that sometimes margin calls go out, and the customer simply doesn’t have the money to pay. That is an ugly situation that can result in liquidating positions, closing accounts and facing lawsuits.

We err on the side of safety. Buying on margin might be OK if you are a day trader who has the right tools and is operating in real time and keeping an eye on things. But if you are a short term investor or even a long termer, you have to be extremely careful if you are going to employ margin. You cannot buy something on margin and sit back and forget about it. A bad market stretch can get you in a boatload of trouble.

If you employ margin on a position, make sure to place a mental or mechanical stop loss on the stock and STICK WITH IT! No one likes to take a loss, and the prevailing thinking is, "It'll come back." If it doesn’t recover, however, you could get a margin call asking for more money.

Also, make sure to pay close attention to your holdings. If the market goes into a tizzy, cut your losses quickly. Play it safe with margin or don’t play at all.

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