Margin Trading: The Risks
AAA
  1. Margin Trading: Introduction
  2. Margin Trading: What Is Buying On Margin?
  3. Margin Trading: The Dreaded Margin Call
  4. Margin Trading: The Advantages
  5. Margin Trading: The Risks
  6. Margin Trading: Conclusion
Margin Trading: The Risks

Margin Trading: The Risks

It should be clear by now that margin accounts are risky and not for all investors. Leverage is a double-edged sword, amplifying losses and gains to the same degree. In fact, one of the definitions of risk is the degree that an asset swings in price. Because leverage amplifies these swings then, by definition, it increases the risk of your portfolio.

Returning to our example of exaggerated profits, say that instead of rocketing up 25%, our shares fell 25%. Now your investment would be worth $15,000 (200 shares x $75). You sell the stock, pay back your broker the $10,000, and end up with $5,000. That's a 50% loss, plus commissions and interest, which otherwise would have been a loss of only 25%.

Think a 50% loss is bad? It can get much worse. Buying on margin is the only stock-based investment where you stand to lose more money than you invested. A dive of 50% or more will cause you to lose more than 100%, with interest and commissions on top of that.

In a cash account, there is always a chance that the stock will rebound. If the fundamentals of a company don't change, you may want to hold on for the recovery. And, if it's any consolation, your losses are paper losses until you sell. But as you'll recall, in a margin account your broker can sell off your securities if the stock price dives. This means that your losses are locked in and you won't be able to participate in any future rebounds that may take place.

If you are new to investing, we strongly recommend that you stay away from margin. Even if you feel ready for margin trading, remember that you don't have to borrow the whole 50%. Whatever you do, only invest in margin with your risk capital - that is, money you can afford to lose.

Margin Trading: Conclusion

  1. Margin Trading: Introduction
  2. Margin Trading: What Is Buying On Margin?
  3. Margin Trading: The Dreaded Margin Call
  4. Margin Trading: The Advantages
  5. Margin Trading: The Risks
  6. Margin Trading: Conclusion
Margin Trading: The Risks
RELATED TERMS
  1. Ceded Reinsurance Leverage

    The ratio of ceded insurance balances to policyholders’ surplus. ...
  2. Bid Wanted

    An announcement by an investor who holds a security that he or ...
  3. Multibank Holding Company

    A company that owns or controls two or more banks. Mutlibank ...
  4. Short Put

    A type of strategy regarding a put option, which is a contract ...
  5. Wingspread

    To maximize potential returns for certain levels of risk (while ...
  6. Volatility Smile

    A u-shaped pattern that develops when an option’s implied volatility ...
  1. How do you calculate retained earnings per share?

    Research the amount of retained earnings per share compared over time to understand whether or not a company uses its profits ...
  2. What is the minimum amount of money that I can invest in a mutual fund?

    Learn about investing in mutual funds even with a smaller initial investment; there are many funds available to investors ...
  3. Which leverage ratios are most useful for analyzing manufacturing companies?

    See which leverage ratios investors and creditors are likely to use when analyzing the debt burdens for manufacturing companies.
  4. How do I sign up for a TreasuryDirect account?

    Invest in Treasury securities by dealing directly with the U.S. Department of the Treasury online, conveniently managing ...
Related Tutorials
  1. Investing For Safety and Income Tutorial
    Bonds & Fixed Income

    Investing For Safety and Income Tutorial

  2. American Depositary Receipt Basics
    Economics

    American Depositary Receipt Basics

  3. Stock Basics Tutorial
    Investing Basics

    Stock Basics Tutorial

  4. Binary Options Tutorial
    Options & Futures

    Binary Options Tutorial

  5. Top ETFs And What They Track: A Tutorial
    Mutual Funds & ETFs

    Top ETFs And What They Track: A Tutorial

Trading Center