Posted by Blain Reinkensmeyer
September 6, 2007 at 6:49 am
Margin trading is a great form of leverage when investing in the stock market. Not everyone uses it because not everyone is approved for it, and like every form of loan whether it is a home mortgage or a stock position, tricks of the trade always help.
The following are 9 tips to helping you trade your portfolio on margin with success:
- Know the Interest Rate. Just like every loan, there is an interest rate for what you borrow. In the case of the stock market, your online stock broker typically will charge somewhere around 8% a year on borrowed funds (depending on how much capital you have). This means that whatever position you go out on margin with, you need to do better than 8% with on the year. So, if you invested $10,000 of margined funds into stock XYZ, you need to make atleast $10,800 by the year’s end.
- Buy in Blocks, Not One Shot. It is never really a good idea to buy all of your position at once (depending on your portfolio size), and with margin trading this is even more critical to success. Take half the position at first, gain some headway (1 - 3%) and then add to it from there. This will keep your double risk to a minimized level until you have a better probability for the win.
- Understand the Rules. Before trading on margin, know the rules of the game. A regular trader will be able to attain 100% margin on his or her account. But, there are ways to extend this. If you are declared a pattern day trader by the SEC, you can borrow up to 400% of your account at any given time. There are added restrictions though depending on your status. Read the guidelines carefully before making your first trade.
- Margin Calls Are Not Good. You never want to have a margin call on your account, which is when the broker will on the spot liquidate your position to pull their equity out. Every position you initiate will have a specific price level where if reached a margin call will take place, know this level and be extra cautious when dancing around it.
- Use Stop Orders. Stop orders can help prevent margin calls from occurring and also save your butt on taking bad losses. When you trading with 100% margin, you are double exposed to both the upside and the downside. Stop orders are your free insurance policy, so use them.
- Be Extra Cautious of Any News. With any position you hold with margined funds, you need to be extra careful dealing with news releases related to the company. If you know that earnings are due out after the bell and you think you have a 50/50 shot at success, is it worth holding the whole position on margin and risking a potential margin call if the stock tanks after hours? On the flip side, if you have 100% true factual inside information that a stock is going to jump big, why not maximize your gains
- Have Backup Funding. You never want to risk it all, then lose it all, then go into heavy debt because of it. If the stock slips after hours and you have a margin call the next morning, you lost cash on the actual position but also on the margin which you owe on the spot. If the world comes to an end and you lose it all, make sure you have backup cash in a bank account somewhere just in case to bail yourself out.
- Stay Away From Speculating. Speculating with borrowed money is never a smart thing to do period, so why do it with a margined position? Walk into a margined position with a clear cut strategy and a initially high probability of success.
- Stick to Your Game. If you are a Warren Buffet type investor focusing solely on fundamentals for your stock research, than go out on margin only with that strategy. To pull out Technical Analysis for Dummies and start day trading on 400% margin is suicide. Go play the $1 lottery instead and try to win big with a random number sequence.
