Speculative strategies:
Buying on margin

Some investment strategies based on your assessment of what is likely to happen in the securities markets in the short term involve a certain amount of risk.

These include buying on margin, selling short, and momentum investing.

When you buy on margin, you establish a margin account with your broker and deposit at least $2,000 in cash or qualified securities, such as stocks or bonds. When you buy a new security through the account, you can choose to put up only some of the money and borrow the rest — up to 50% — from your broker. The amount you borrow is called a margin loan, and you pay interest on it.

If the price of your new investment goes up, you sell it, repay your margin loan, and pocket the rest, minus brokerage fees and loan interest. When the strategy works well, your return can be much greater than it would have been had you paid the full cost with your own money. That’s an example of using leverage to your advantage.

If the price of your investment drops, you can wait to see if the price will go up again. But since you’re paying interest on the borrowed amount, the longer you wait the more the margin loan will cost you, eroding any future profits. And, if the value of the investment drops below a certain point, which is a preset percentage of your equity, your firm will require you to add enough money to your margin account to bring the value up to that minimum level. That’s a margin call. Your equity is the difference between the market value of the stock and the amount of your margin loan.