The Black Hole of Trading. New Traders BEWARE
Dear Penny Stock Millionaire,
There’s nothing new about buying stocks on margin. Traders, brokers, and investors have used margin for most of the stock market’s lifetime.
At its core, margin is a loan from your broker. And the broker charges an interest rate. Typically, the interest rate on margin is lower than credit card interest. But it can eat into your profit potential if you use margin for an extended period of time.
How Does Buying Stock on Margin Work?
Specific margin interest rates depend on your broker and the overall interest rates in the economy.
To simplify this, suppose your broker charges 10% interest annually for any margin used. If you use margin for a short period, you won’t be charged the full 10% annual rate. The amount of interest you pay for the margin loan depends on how long you hold the stock position.
Here’s how you can calculate the borrowing cost:
- Take the amount of money you borrowed. Let’s say $5,000 for this example.
- Multiply that amount by the interest rate ($5,000 x 10% = $500).
- Divide the calculated number by the number of days in a year ($500 / 365 days = 1.369).
- Multiply by the number of days you used the margin, for this example 10 days (1.369 x 10 = $13.69)
In this example, if you hold the stock for ten days, you’d pay $13.69 in interest on the $5,000 margin to purchase stock XYZ.
The Advantages of Buying on Margin
I’m sure you can imagine the massive advantages of using margin with your investing. It can be tempting to want to go all-in with margin. But it’s extremely dangerous.
Could your investment double? Sure…
But it could just as quickly DROP by 50%.
One good trade could potentially be life-changing, but you can’t think of the stock market like a lottery ticket. If you do, you’re thinking like a gambler, and that will get you into BIG trouble.
It takes time to become a consistent trader. One massive trade won’t make that happen. All of my top students learned to take small wins and cut losses over and over again. That’s exactly what I teach.
The Risks of Buying on Margin
From all the people I’ve taught over the last ten years, very few were successful using margin in their first few years of trading. The leverage is too dangerous for newbies.
The learning curve for trading is steep. A lot of people blow up their accounts along the way. Some grow impatient and dissatisfied with small gains. So they think it’s smart to use margin.
Buying stocks on margin is like playing with fire. I say this a lot: Never risk money you can’t afford to lose. If you’re using margin, odds are you don’t have enough money in your accounts to place that trade.
Sadly, for many newbies, buying on margin only increases the chance that they’ll blow up. Don’t fall for this trap.
Learn how you can trade small and take singles — without using margin. Don’t rush your process. That only leads to destruction and disappointment.
My goal is to teach you to be a self-sufficient trader, so you can trade through any kind of market.
Frequently Asked Questions About Buying on Margin
I talk to so many traders on social media. Across all my channels, traders ask me the same questions about margin and buying stocks on margin.
To save everyone some time, I compiled some of the most frequently asked questions I’ve gotten over the last few months about buying on margin…
‘Is Buying on Margin a Good Idea?’
In my opinion, in 99% of cases, buying on margin is a bad idea. I’ve seen far too many good traders blow up because they borrow and then let a position get out of control.
Traders can use a margin account so they don’t have to wait for their cash to settle before placing another trade. But just because you can use margin doesn’t mean you SHOULD.
‘How Can Traders Benefit From Buying on Margin?’
Buying on margin can increase your buying power. Trading large companies is nearly impossible with a small account. Amazon (NASDAQ: AMZN), for example, trades for almost $2,000 a share. If you only have a $2,000 account, you can only buy one share of AMZN.
Using margin on well-established companies can be beneficial. Typically these companies move less than 10% a year. Using a standard margin account, those returns could be doubled.
‘Why Is Buying on Margin Dangerous?’
It’s much easier for a stock to lose 50% of its value than to gain 100% of its value.
When buying on margin, the danger comes from the increased risks and odds of blow up. After you buy a stock on margin, you’re responsible for all the losses. Even though you technically only own half of the position.
Trade smart — avoid margin. None of my top students use margin anyway.
‘How Did Buying on Margin Contribute to the Great Depression?’
Buying on margin helped cause Black Tuesday, which started the Great Depression. Prior to the Black Tuesday crash, people around the country were using massive margin. They sometimes used 9:1 leverage to buy stocks at inflated prices.
A lot of U.S. citizens were overconfident in the economy and stock market. Due to a large amount of margin available in the market, stocks went up too fast. That caused a bubble. When the bubble burst, it nearly crippled the entire U.S. economy.
‘Who Should Buy on Margin?’
Only experienced traders. I’ve never used margin and probably never will. Most traders should avoid margin, especially if they’re trading sketchy penny stocks.
There’s a risk with every investment. Some people have a higher risk tolerance than others and won’t heed my advice. That’s fine.
They’ll be the most likely to blow up their entire accounts.
I’m not a huge proponent of using margin to buy stocks. The risks far outweigh the potential returns … especially when you factor in interest and fees.
Also, I think we’re at a turning point in the global economic cycle. For the last 10 years, the world has experienced the longest bull market in history. It’s only natural that we’ll experience a pullback. In other words, buying anything on margin today is highly risky.
I know there will be some people who will bash my advice because they got lucky and doubled their account. Cool — good for you. I’m curious where you’ll be in a year.
Meanwhile, my students and I will keep focusing on taking singles and cutting losses quickly. We aim to grow our accounts one trade at a time.
Editor, Penny Stock Millionaires