Margin, investor’s siren song, is often hard to resist. The temptation of leverage to see huge returns, portfolios rocketing into the millions, it is the fantasy. So what keeps us from throwing caution to the wind, trusting our instincts and research, and leveraging to our eyeballs for big wins? The margin call.
When you buy stocks on margin you are borrowing money for a portion of the purchase. Typically average investors can only borrow half of what they wish to purchase. Crazy hedge funds can get away with borrowing much much more.
If your investments fall in value and the amount of your investments is worth an amount close enough to the amount you owe the brokerage may initiate a margin call. In most instances they will sell enough stock, regardless of the price, to pay off your loans usually leaving you with nothing or near nothing. Unless you are well established you have very little say in the manner. Any firm you buy stocks on margin with should provide a margin call formula or margin call calculator so there is no misunderstanding on when your account will be in danger.
Having your stocks sold on a margin call has two devastating impacts to the investor. One is the stocks are sold when the price is down. This is usually the exact opposite of when you wanted to sell unless it saved you from a plummeting stocks. The other negative impact is to the psychology of the investor. They now feel defeated and will be less capable of pulling the trigger on the next good investment they come across. Hesitation on a well defined plan leads to lost profits.
Margin needs to be used as part of a well developed plan and not a guarantee of massive gains. If your losses aren’t minimized to smaller swings than your wins than high margin accounts will wipe you out.
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