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I am extremely excited to announce my new e-book, SOLID STOCK SELECTION is now available !! Click here to find out more.
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9/10/2006 Trading 'On Margin' This is getting a bit away from ‘understanding market basics,’ but sometimes terms come up in conversation and you want to know what they mean. So here’s what ‘Trading On Margin’ means. I’ll start out with the basics and move on from there. If you have a large enough account with your brokerage firm (whether it is a brick and mortar broker or an on-line account) you can trade on margin. This means that you are buying stock for a percentage of the actual price, with the promise that when the time comes you will be responsible for the entire price. Sound confusing? It really isn’t, but you can get in over your head, if you either don’t know what you are doing, or the stock moves in an unexpected direction quickly. If a stock is selling for $100 and you think it is going to move to $110, and you want to load up on it, but you don’t have the capital to do that, you can ‘buy on margin.’ This means that you will actually be borrowing the money to buy the stock from your broker and paying the interest for the loan while you own the stock. This will allow you to buy a larger block of stock, but will also put you into debt until you sell. If the stock does not rise, you will lose the interest you pay on the loan, plus brokerage fees. If the stock drops substantially you can also have to repay some of the loan principle out of your pocket. This is a risky business in many ways. However risk can pay off big, or cost you big, depending on the direction the stock goes. Two examples
1. You buy a block of stock for $10,000 on margin. You hold the stock for 1 year, paying 5% interest. (Cost of the interest is $500.) At the end of one year you see a rise in price of 15%. You sell the stock for $11,500. Total cost $11,500 minus $10000 minus $500 minus $40 broker fee = $960. 2. Same situation, but the stock loses 10% over a year. Total Cost $9,000 minus interest cost of $500 minus broker fees of $40 = loss of $1540. I made this more extreme than real life. Most likely trading on margin, one would not pay 5% interest or hold the loan for a full year. In either example, you have no initial out of pocket expense and the grass on the other side of the fence starts out looking pretty green. Two final notes, the 'on margin' refers to the margin of difference between the Treasury Index rate (determined by the Fed) and the actual rate at which you are borrowing the money. Trading on margin is an advanced technique, not to be lightly undertaken.
That's all for this week, Rob
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Want a scholarship into the Millionaire Mind Intensive worth $2590? http://www.secretsofthemillionairemind.com The columns, articles, message board posts and/or any other features provided on Wealth Training Source are provided for personal finance and investment information and are not to be construed as investment advice. Under no circumstances does the information in this content represent a recommendation to buy, sell or hold any security. The views and opinions expressed in an article or column are the author’s own and there is no implied endorsement by Robert Britt of any advice or trading strategy copyright Robert E. Britt 2006 |
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