Margin Buying Basics | by Wall Street Survivor
#Opening a margin account allows you to trade on borrowed money. You have to open up a margin account when shorting stocks because you’re borrowing the stock rather than purchasing it. In order to maintain a margin account, you must have collateral to assure the broker that he’ll get his money back. Collateral is something (in this case money) that the borrower gives the lender as protection in case he fails to pay back what he owes.
Buying on margin is when you take out a loan to buy a stock.
This process is also called leveraging your position.
Margin basically means collateral.
When you buy on margin, the stocks you buy are kept as collateral until you pay off the loan.
The concept is similar to getting a mortgage to buy a house.
The bank keeps the house as collateral until the day you pay off the loan in full.
Why would you buy a stock on margin?
Well, either you don't have enough money for the entire purchase, or you want to magnify your gains.
So how does it work?
Here's Frank.
Frank wants to buy a Google stock, which is currently trading at $500.
He wants to buy it on margin, so he contacts his broker.
His broker tells him that his margin requirement, or the amount that Frank needs to contribute, will be 70%.
This means that Frank has to put up and maintain 70% of the price himself, and the broker will put up the remainder.
Since the stock price is currently at $500, Frank will have to pay $350 for the stock, and the broker will put in the remaining $150.
Let's say that Google rises to $600 and Frank is happy with the return.
His broker will sell the stock for $600, redeem the loan of $150, and give the remaining $450 back to Frank.
Great! Frank made a profit of $100.
Since he only put in $350, his gain is 28.5%.
So what would have happened if Frank would have bought the stock the old-fashioned way?
Well, Frank would have bought at $500, sold at $600, and made the same $100 profit.
But he had to put $500 up front to purchase the stock, which means that his percent gain would have only been 20%.
By using margin, Frank magnified his gains and made an extra 8.5%.
Buying on margin is extremely risky and should be used with caution.
Just as Frank's gain was magnified, his losses would have been magnified as well.
In fact, if the stock price had really plummeted, Frank could have lost more money than he had, driving him into debt.
You can practice buying on margin risk-free by signing up at wallstreetsurvivor.com.