Margin Funding: merits and demerits (1)
June 13th, 2008 Ikechukwu Emelike || ikechukwu@stockmarketnigeria.com
Margin Funding allows you to borrow against the securities in your portfolio, it is buying stocks without having the entire money to do it. The amount you can borrow depends upon the type and value of securities in your account. As long as you keep sufficient collateral in your account, your loan can remain outstanding until you choose to pay it down. If your account value drops below the requirement, you will need to deposit additional cash or marginable securities. Once a trader buys stocks in the margin account, the client gets the profit/loss since his purchase in his account.
Broking houses see margin funding as an area that would help boost their bottom lines. This also helps them morph into a one-stop-shop for the investors. Though brokerages officially claim that margin funding is made available only to specific clients who are aware of the legalities and risks involved, officials concede that most customers are approached with this option. Compared to high net worth individuals, opting for margin funding by retail investors is a more risky proposition, according to financial advisor’s. Retail investors may not understand all the risks involved. If stock prices fall, investors could end up losing much more than their capital.
When clients are not able to meet the margin requirement, the broker sells the security so that he does not have to bear the risk in case the stock falls further. This erupts to a problem when the markets fall far more than expected and traders are not liquid enough to meet the margin calls. And when a lot of traders can’t meet margin calls, the situation snowballs. Trading on margin can be a profitable investment strategy, but it is fundamental that you take the time to understand the risks.
The following tips could come in handy:
- Make sure you fully understand how your margin account works. Be sure to read the margin agreement between you and the clearing firm. Talk to your account representative if you have any questions.
- Monitor your margin balance on a regular basis and utilize stop-loss orders on every open position to limit your risk.
- Have it in mind that the positions in your account could partially or totally be liquidated should the available margin in your account fall below a predetermined threshold.
- Do not use your entire account balance as margin for open positions. Instead, leave enough funds in your account to withstand a market movement against your open positions.
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Trading on margins is recipe’ for high lending and real time inflation. It is mainly operational to the cost of the secondary party…which can compulsorily make active traders rich…usually select few and rest of them poor. You can look at quotes…and what panic can do.
It naturally spills over to safe grounds and ‘targets’ and may constitute ‘nuisance’. It can encourage bait.It is better to place bait on some else but there is always ‘net stock profit’ problem that naturally force agents to auction off collateral. This naturally inflate equity prices as both parties seek to generate enough to earn and from that inflation’crack’there are degrees of ‘inevitability’. Ask LEHMAN if this is encourageable