The Danger of Buying on Margin

The Chinese stock market is falling again. What this brings to mind is the danger of buying on margin when investing in stocks. The New York Times writes that Chinese shares tumble again.

After several weeks of relative calm, tumult returned to China’s stock markets on Monday, casting doubt on the government’s measures to support share prices.

The main Shanghai share index plunged 8.5 percent on Monday, its steepest one-day drop in eight years. Shenzhen’s main index fell 7 percent.

“The return of debacle!” China’s official Xinhua news agency said Monday on its verified Twitter account, noting that in the sell-off, about two-thirds of all mainland-listed stocks fell by the daily limit of 10 percent.

For more than a year, the country’s stock market soared, as investors aggressively borrowed money to buy shares.

The danger of buying on margin is that if you do not get in and out in a hurry you run the risk of losing all of your investing capital in a market downturn. When many investors are in the same situation of having borrowed money to invest a stock market correction can turn into a stock market collapse. Three trillion dollars-worth of equity or more has evaporated in the last couple of months in the Chinese markets. But the lesson is good for all investors to learn. There is danger in buying on margin. Should this approach be avoided at all costs or can an investor do this and not get hurt?

Fundamentals versus Market Sentiment

There are two sets of fundamentals that drive stock share prices. How much money does a company make and how much will it make in the future? The other is how much money is invested in a company, by whom and how likely are they to buy or sell. This second set is closely tied to the other driver of the market, market sentiment. It goes like this. A stock or the entire market has a good quarter and the stock price goes up. This happens again and again and those who invested early in the game have made money. New investors judge the stock on its recent performance and do not look at the basics. By now the stock is priced above what the basic set of fundamentals will support. Speculators and hedge funds have purchased large blocks of the stock for short term profit. Cramer in The Street writes about a stock downfall not caused by fundamentals.

Williams Partners (WPZ) stock is up by 1.78% to $45.14 in pre-market trading on Friday morning, after Jim Cramer attributed the recent decline in its share price to hedge funds on CNBC’s Mad Money Thursday night.

TheStreet’s Jim Cramer, Portfolio Manager of the Action Alerts PLUS Charitable Trust Portfolio, said some hedge funds have to liquidate their share, which will continue to make master limited partnerships (MLPs) fall.

The danger of buying on margin such as with a hedge fund is that you can get on the wrong side of a trend and have to sell at lower and lower prices in order to avoid a margin call. And as short term speculators who hold large positions sell in larger and large quantities you stock price falls a well.

Where Does Buying on Margin Work Out Well?

People make money investing in stocks when they do their homework. Sears Holdings Corp went public in 2003 for $13.20 a share. When seen as a real estate play the stock went up over next four years to nearly $200 a share! Sears Holdings Real Estate is still one of the largest corporate real estate organizations in the world.

Sears Holdings Real Estate is one of the largest corporate real estate organizations in the world, with a portfolio of retail locations that is second to none. Whether you are a retailer, developer/investor, or broker, we have a solution to fit your need.

The stock is back in the $20 range but the point is that there was a lot of money to be made when the stock went up steadily from $13 a share to nearly $200. That is where buying stock on margin can work out well. It has to do with homework and timing.

The Danger of Buying on Margin PPT

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