Trading on margin is the most powerful and yet most dangerous weapon on Wall Street. Buying and/or arbitraging on margin (borrowing money from your broker to buy securities) is extremely dangerous, and you must understand its risks before even trying it because you may lose more money than what you could have invested.
Federal Reserve Board Regulation T allows you to borrow up to 50 percent of the total purchase price of a stock when building a new position.
Minimum Margin – initial account balance, usually $2,000.
Initial Margin – the base amount of leverage allowed, usually 50%.
Maintenance Margin – the market value that your equity must hold before receiving a margin call, usually 25%.
Margin Call – broker request for collateral.
The cost of trading on margin includes both the amount you borrowed and its interest, which must be paid even if you lose money on your trade. Risks involve included, but are not limited to, the forced and unannounced sale of securities in your account, without contacting you or even giving you a choice on margin requirements and without an extension of time to meet margin calls. On margin trading, all other previous guidelines remain in effect:
- Never meet a margin call.
- Never average cost down on margin. Don’t even think about it.
- The yield of the security you buy on margin has to be greater than the borrowing cost in combination with the delta. (Delta % + Margin Interest Rate %)
- Margin should only be used on positions that are already showing you a profit. (Average Cost Up)
THE STRUCTURE OF A MARGIN TRADE
Once the position has an unrealized gain greater than 20%, you may double the allocation with margin. Right there and then, you have to place a “good until cancel” order with a stop for loss for 5% of your unrealized gain. Reprogram the order if necessary. Just get out of the trade before the position (P&L) shows a zero or negative return. ( a < 0% gain)
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