[Lou] Matt from Washington: "What should I worry about when trading on margin?" Quick: what is margin?
[Randy] Margin is what gives you the ability, if you want to buy $10,000 worth of stock is you only have to come up with $5,000 and you can borrow the other $5,000 from Schwab. The simplest answer—and I've written a few articles on margin is basically this: think of margin in some sense as like a credit card. Just because you have a credit limit that's here doesn't mean you should spend all of it. You don't really ever want to get to that point. Because what ends up happening is if you spend all of your margin and we go into a pullback like we just had in October some people got caught off-guard and they were contacted and told, "Hey, we need you to bring in additional money because your equity has gone too low."
The problem with that is that when you get to the point where you've got to come up with more money and if you can't you're going to be forced to sell positions it's going to happen at the absolute worst time.
[Kevin] Always does.
[Randy] So my single piece of advice on margin is just this: don't ever get anywhere close to your maximum available borrowing. I'll leave it there and let you guys jump in.
[Kevin] I think you're right on the money as usual, Randy. I'll also just point out that the difference between a credit card and margin is your availability fluctuates. So where you might have a $20,000 credit card limit if you have a $20,000 margin limit today tomorrow morning that could be 15 and you owe 5. Or it could be bumped up due to market appreciation; suddenly you have more, you're thinking, "Okay, I'm a little fat and happy. I can do some more investing, more trading." But it also can get you in more trouble.
[Randy] Margin's a double-edged sword. I know I said I wasn't going to comment but I want one more thing: margin is a double-edged sword. When things go well you'll make more money but when things go down you'll lose more money so you've got to always keep that in mind.
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When considering a margin loan, you should determine how the use of margin fits your own investment philosophy. Because of the risks involved, it is important that you fully understand the rules and requirements involved in trading securities on margin.
• Margin trading increases your level of market risk.
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• You are not entitled to an extension of time on a margin call.
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