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Nightly Topic Post. Dangers and benefits of

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Garyst Member Level  Tuesday, 11/13/12 08:32:06 PM
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Nightly Topic Post. Dangers and benefits of trading on margin. Firstly very few if any venues allow one to trade Pennies utilizing margin funds. This post will basically be reflecting those that might invest in Dow, Nas and Amex stocks where margin trading is feasible.

Most companies have a minimum account balance before one can trade on margin. For instance at Etrade it is $1000.00. Margin trading allows one to "borrow" fund up to 1-2 times their account balance to buy stocks depending on the sepcific security. Most trading venues have a Table for all Tickers and shows what the margin max percentage is that you can "Borrow" from your trading venue.

Lets say you have $1000.00 and want to buy ABCD. Your trading venue allows up to 2 times your amount to margin trade. You now have $3000.00 to buy that security. It all sound good and can be but it can also be disastrous if one is not careful.

The good scenario: You buy in with 3k (1k of your money and 2k on margin) and the stock is trading at $10.00. You have 300 shares. Lets say the pps goes up 33% to $13.33. Your shares are now worth $3999.00 when you sell. You pay back your original margin amount of 2k and you have just doubled your 1k of your own money into 2k. It works out well when a stock goes up.

The dangerous scenario: Lets say you again do the above and buy 300 shares but this time the pps drops 33% and is now at $6.66. Your 300 shares are now worth $1998.00. You still owe your trading venue 2k that you borrowed and they now place a "margin call" on your account. A "margin call" is basically your venue wanting their money back as you are now getting close to negative. They may give you the opportunity to sell out or they may sell your shares at their discration to get their 2k back. You pay the 2k back and guess what? You have now just lost your whole 1k that you started with and have nothing left. Lets say the pps went down even lower than 33%. Now, not only is your account balance at 0 but you are in the "Hole" and have to come up with the additional funds to pay them back their 2k.

Margin trading can be good but also disastrous. I traded on margin back in the early 2000's and in the "Dot com" era when on almost anyday IPO's (Initial Public Offerings) would double and triple. Many did very well back then with margin trading and then the market crashed. I ended up getting hurt badly by continuing that practice and have now not traded on margin for the past 10 years. I personally would not advise it.

Hope this made sense.

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