Margin Trading: The Risks
  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

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
RELATED TERMS
  1. Margin Call

    A broker's demand on an investor using margin to deposit additional ...
  2. Buying On Margin

    The purchase of an asset by paying the margin and borrowing the ...
  3. Margin

    1. Borrowed money that is used to purchase securities. This practice ...
  4. Maintenance Margin

    The minimum amount of equity that must be maintained in a margin ...
  5. Trading Margin Excess

    The funds that remain in a margin trading account that are available ...
  6. Margin Debt

    1. The dollar value of securities purchased on margin within ...
RELATED FAQS
  1. Why is purchasing stocks on margin considered more risky than traditional investing?

    Learn why purchasing stocks on margin is riskier than traditional investing, although it can be more profitable when it is ... Read Answer >>
  2. What is a margin account?

    A margin account is an account offered by brokerages that allows investors to borrow money to buy securities. An investor ... Read Answer >>
  3. What happens if I cannot pay a margin call?

    Minimum margin is the amount of funds that must be deposited with a broker by a margin account customer. With a margin account, ... Read Answer >>
  4. What does it mean when I get a Fed margin call?

    Learn what a fed margin call is, what it means when you receive one and what steps you must take to satisfy the fed's requirements ... Read Answer >>
  5. How much can I borrow with a margin account?

    Understand the basics of margin accounts and buying on margin, including what amount investors can typically borrow for purchases ... Read Answer >>
  6. What is the difference between leverage and margin?

    In financial terms, leverage is reinvesting debt in an effort to earn greater return than the cost of interest. When a firm ... Read Answer >>

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