How to Succeed at Investing in Stock on Margin - dummies

How to Succeed at Investing in Stock on Margin

By Paul Mladjenovic

Margin can escalate your investment profits on the up side but magnify your losses on the down side. If your stock plummets drastically, you can end up with a margin loan that exceeds the market value of the stock you used the loan to purchase.

In the emerging bear market of 2000–2002, stock losses hurt many people, and a large number of those losses were made worse because people didn’t manage the responsibilities involved with margin trading. In 2008, margin debt again hit very high levels, and that subsequently resulted in tumbling stock prices.

If you buy stock on margin, use a disciplined approach. Be extra careful when using leverage, such as a margin loan, because it can backfire. Keep the following points in mind:

  • Have ample reserves of cash or marginable securities in your account. Try to keep the margin ratio at 40 percent or less to minimize the chance of a margin call.

  • If you’re a beginner, consider using margin to buy stocks in large companies that have relatively stable prices and pay good dividends. Some people buy income stocks that have dividend yields that exceed the margin interest rate, meaning that the stock ends up paying for its own margin loan. Just remember those stop-loss orders.

  • Constantly monitor your stocks. If the market turns against you, the result will be especially painful if you use margin.

  • Have a payback plan for your margin debt. Taking margin loans against your investments means that you’re paying interest. Your ultimate goal is to make money, and paying interest eats into your profits.