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You have done the research. You have read all the news, you have studied the charts, you have checked the insider selling and buying and you have gone over the financials of the company and have decided that this is the stock you are going to buy. You would like to buy 400 shares of this hot stock, but you only have enough money to buy a little over 200 hundred shares. What can you do? You can buy on margin. Margin allows you the opportunity to significantly multiply your profits. Sounds great! What's the downside? In short, you can significantly multiply your losses.
How does margin work?
You want to buy a stock, name: "Unlimited Potential" stock ticker symbol: "UP", that you believe will continue to run up in price. You check your account balance and find you are already fully invested and you don't have anymore money left in your cash account. You decide the stock "UP" is just too good to pass on so you borrow the money from your broker and buy the stock on margin.
Before you can purchase or sell anything on margin you need to open a margin account. If you would like to do so, request a margin account application from your broker. Once you have been approved, you may now borrow money from your broker to execute trades. The SEC (Securities and Exchange Commission) and each broker have rules as to the amount of money you can "margin" and which securities can be bought and sold on margin. You are charged interest for the amount borrowed.
Why use margin?
Hopefully, the stock you bought goes up a significantly higher percentage than the margin interest. Typically, the interest on margin accounts is very low. Of course if you take a loss on the stock, it's a double whammy. You lose money on the investment plus you still have to pay the interest on the original amount borrowed.
Example of the power of margin
Your account has $5,200 in it available to buy stock. You believe "UP" (the stock mentioned earlier) which is trading at $50 per share is going to go up, of course! You can only buy 100 shares at $50 per share without using margin. However, you want to buy 200 shares because "UP" is a hot stock and you have done your research and you are impressed with it. You only have $5,200 in your account so to buy the 200 shares on margin your broker lends you the $5,000 extra you need to make the purchase. The stock "UP" goes up from $50 per share to $60 per share and you make $2,000. Compared to your original investment of $5,000 (your original money portion), you have made a return of 40% (less commissions and margin interest) instead of a return of only 20% if you only bought 100 shares. You can double your profit by borrowing a little money! Of course, if you take a loss on the stock then you DOUBLE your LOSS! So be careful.
Margin is a very powerful tool for investors and should be used with caution. If you have done your research and are confident about the stock then using margin to pick up some additional shares is an excellent way to boost your gains.
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