How to Trade Stocks - Margin

Margin lets you borrow money from your broker using securities in your account as collateral. Margin is regulated by the government. You can borrow up to 50% of the value of the stocks in your account, more with bonds. It works like this: if you have $5,000, you can buy $10,000 worth of stocks. If you own $10,000 in stocks (fully paid for), you can pull out up to $5,000.

Your broker will charge you monthly margin interest based on a sliding scale: the more you borrow, the lower the interest.

But be careful: you must maintain a minimum equity in your account of 25-30%, meaning that if the value of your portfolio declines below the threshold, you will get a margin call from your broker for more cash. If you don't deposit it (answer the margin call), the broker will sell your stocks to pay off the loan.

Lower priced stocks are not marginable. Every broker has a list of marginable and non-marginable stocks from their margin department. If a stock is not marginable, you must pay 100% of the price at the time of purchase.

Margin can magnify your gains and losses.

Let's say you use $5,000 to buy 500 shares of a $20.00 stock, for a total of $10,000 (50% margin). If the stock goes up to $30.00 the value of your account goes up to $15,000. When you sell, $5,000 goes to pay back the margin loan. You get to keep the $10,000. You just doubled your money while the stock went up 50%. That's the power of margin/leverage.

If, on the other hand, your stock drops to $10.00 (a 50% move in the other direction), the equity in your account is wiped out, since you still owe the broker $5,000 plus interest. In reality, you will get the margin call and/or sold out before it gets to that point.

Tip: Never answer a margin call. Your stocks are down as it is, why throw good money after bad? You should have cut your losses long ago. Just let the broker sell you out, and start with a clean slate. As long as you have cash, there is always another opportunity you can take a shot at. But if you lose more money covering declining stocks, you may never get that second chance if you get wiped out.

So why use/have margin?

1) You never have to worry about the exact amount when buying a stock. Going on margin 5-10% is no big deal: there is ample equity to protect you on the downside. Just don't trade heavily on margin while you are learning.

2) Margin can help you manage your cash flow by providing additional credit.

3) Most mutual funds are marginable after 30 days. Margin requirement for corporate bonds and Treasuries is less than 50% (meaning you can borrow more). You can buy a mutual fund and/or Treasuries with the cash and trade stocks occasionally on margin. Mutual funds and Treasuries don't lose as much value as individual stocks, giving you an extra safety cushion. Interest you collect on bonds can defray margin costs. And having stocks on margin will keep you on your toes.

On the other hand, do not get approved for options or futures. These instruments let you use even more margin for even bigger gains but can as easily wipe you out.