Buying Stocks on Margin
Buying on margin is borrowing money from a broker to purchase a number of stocks. In other words, it’s simply a loan from your broker. The process of buying on margin allows you to purchase more stocks than you normally would.
Borrowing money isn’t free. First you need to repay the loan, and also you need to pay interest fees monthly. It’s suggested to buy on margin during a bull market and do it for short-term investments only. Because, the longer you hold the loan, the more you need to make in order to break even.
For example, let’s say you have been following a stock for a period of time, and now you believe it is undervalued and thus the price of the stock will soon increase. The appropriate action in this case would be to buy the stock now at the low price and sell it when the stock price rises. But your problem is that you don’t have enough money to finance the full transaction. Don’t worry! You can borrow some of the money from the broker and thus buy the stock on margin.
To summarize, when you buy on margin, you:
- pay for a certain percent of the stock initially.
- borrow the rest of the money from the broker, which you need repay later.
- pay interest on the amount borrowed.
- pay broker’s fee when the stock is bought and sold.