Buying on margin essentially means that you are buying stocks with borrowed money. Suppose, you want to buy 100 shares at P71.80 per share of DMCI Holdings shares, but you don’t have P7,180. If you qualify, the brokerage firm that you are purchasing this stock will lend you up to 50 percent of the amount you need to purchase the DMCI stocks. So all you have to do is fork over at least P3,590 and you will be the proud owner of those 100 DMCI shares of stock. In that case, you have just purchased stocks on margin.
When you borrow money from a brokerage firm, they are going to charge you interest. This interest is another source of income for them. Also, they are going to hold the stock as collateral against the loan. Thus, the firm has nothing to lose and everything to gain. Why do people buy stocks on margin even though it costs them a lot? The reason is leverage. They do this in the hopes that their stock will go up and they will make twice as much money as they would have if they had simply bought half as many shares. As long as their additional profit exceeds the interest they have been paying to the brokerage firm, they are sitting pretty.
The danger for the investor comes in when the stock bought on margin goes down in price. By law, the firm can never let the collateral fall below a certain percentage (usually 30%) of what they have lent. If the stock goes below that amount, the firm issues what is known as a margin call, which means that the investor have to come up with the amount of money needed to bring the firm’s risk down to the required level. If you don’t have the money to do this, the firm will sell your stock and take their money back. If there is any money left, they return it to you. Buying on margin can increase your reward, but it also seriously increases your risk.