James here about the perils of buying stocks on margin. Many of us who need money attempt to fill the gap with that one large stock trade which will bail us out of our financial woes. One tool used by stock traders looking to make a killing is called margin. This is when your broker lends you a portion (typically half) of the purchase price of your stock. Consequently, this enables you to increase substantially your gains — if the stock goes up. However, if the stock goes down, then your broker will force you to start repaying the amount owed on margin. If you can’t repay this amount, then your broker will sell your position resulting in a big fat loss. When buying stocks on margin, not only to you have to be right, but the stock has to head straight up right from the time you buy it.
If you buy a stock outright without using margin, then you can afford to watch it temporarily decline before going back up again. When you are on margin, then an initial decline can end the game before it even begins. If any of your buddies or the stock “guru” in your office suggests you buy a stock on margin — run far and run fast. I will admit that I gave in to this temptation many years back, and I learned my lesson about margining stocks the hard way. Hopefully a few of you will avoid that hard lesson by heeding what I am saying now.