About using margin

I walked past a newsstand today and saw the Wall Street Journal with a headline saying that record levels of margin contributed to the recent sell-off when people got margin calls. Let aside the “record levels” don’t mean much if they are talking about dollar amounts, considering that the market contains much higher value than it used too. However, please don’t try to increase your results by using high levels of margin, especially when the market is making new highs all the time. Remember your broker who may allow you 50% margin (for instance) now on aggressive stocks, but when the market starts down your broker may get scared too, and say, overnight (!), that you need 100% for that stock, and suddenly, if your margin level is too high, you have a margin call! I don’t think I’m ever more than 4% total of my portfolio on margin, and I get just fine results without that leverage, and I’ve never gotten a margin call. So be very careful with margin… especially when the market is going up.

Best,

Saul

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For those not familiar with Reg T accounts, it’s very helpful to know there’s a difference between having a negative cash balance thereby taking out a margin loan versus using the margin in your account to back stop short option trades such as put writes and synthetic longs. If you ever want to upgrade your brokerage account please take heed of the nuanced understanding regarding margin cushion, margin maintenance and how you your net liquidation value can be impacted. Most brokerages will provide a heads up if margin maintenance is about to change on a particular equity. Moreover, some brokerages allow several days to handle a margin call unless your with Interactive Brokers which conducts real time margining in exchange for the lowest comms out there.

Over at Motley Options, there’s some great guidance so you can get the correct education and not be blind sighted with a hard luck lesson.

Options should be used to leverage returns responsibly. Valuation first then option strategy!!!

The scams hawking binary options - crap! Those hawking option strategies with no valuation, just reading the greeks - mostly crap unless you have the resources of a brokerage house.

~Scott

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I agree 100% with this.

I have used margin in the past, and at times it boosted my performance during normal market conditions. However, during the dot.com bust, 2008 mini depression, and other major sell offs over the years having a margin call can destroy your portfolio. Ask yourself this question–would you add cash into your account to prevent selling stocks once you get that margin call. Very few would during a major sell off/crash, due to the fear of losing even more. This then results in being forced out of stocks you want to keep. When the market eventually heads back up, you don’t have the shares to recoup your initial portfolio’s value before the sell off.

Margin also gives you a false believe–it is not my own money, so I can take greater risks. Using your own money forces you to be a little more thoughtful. Bottom line–don’t get greedy on that “sure” thing and use margin–it has bad outcomes long term.

As Saul indicates a small amount can work. However, I would only do that on a great deal, on a stock you have owned for a long time that is reacting to the market.

These days I don’t use margin at all, even for great deals. Instead- I keep a small percentage in cash for deals-such as NVDA the other week. If you don’t have the cash then sell a lower performer and use that money for the high conviction deal.

David

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Buffet quoting Munger, "“My partner Charlie says there is only three ways a smart person can go broke: liquor, ladies and leverage,” he said. “Now the truth is — the first two he just added because they started with L — it’s leverage.”

The more volatile your stocks the more dangerous margin (leverage) is. We invest in volatile stocks here, invest carefully. Greed can make you do unwise things.

-e

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Remember your broker who may allow you 50% margin (for instance) now on aggressive stocks, but when the market starts down your broker may get scared too, and say, overnight (!), that you need 100% for that stock, and suddenly, if your margin level is too high, you have a margin call!

I think it’s probably wise never to bet on someone else’s rationality. It’s hard enough to maintain your own.

Bear

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Big no to margin under any circumstances for me. Too many variables, as noted above.

I doubt anyone here frequents Reddit investing boards(there’d be no reason to, really, as it is mostly bitcoin worshippers and very young day traders) but during the recent “meltdown”, lots and lots of those folks had been using margin heavily…and the result was not pretty. To their credit, many of them posted screenshots showing their entire port wiped out as a warning to others. A good lesson early in the game for some of them, hopefully.

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One of most rec’d posts ever:

http://discussion.fool.com/the-real-real-risks-of-margin-1225137…

I am surprised you ever use margin at all, Saul.

DT

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I am surprised you ever use margin at all, Saul.

Hi DT
When I see something I really want to buy and I don’t want to sell anything, up to 4% of my portfolio is an irrelevancy to me (remember I have enough living money for a while in my checking account). Then the next time I sell something I pay down the margin. My current margin position is one-tenth of one percent of my portfolio, for example. It’s not a major investing strategy for me, just a convenience.

Saul

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I do hope that fella who lost all on CRA stuck with it and came back. It is the key to life, to persevere. And comeback is possible.

I am with Saul on this one, use margin for convenience. My margin is 4% or less of my account balance. There will be no margin calls.

But it does become enticing to use more and more margin once you start using it. Kind of like a gateway drug.

What you have to remember is to stay within yourselves. Consistency, being systematic, and time will take care of everything. This fella who lost it all on CRA, had he started over, investing monthly into the best companies in the world, no 17 years hence, imagine how large his port would be now! Age 44, and he would have a huge portfolio. I hope would, is really he does have.

That sort of discipline is hard to come by, but it puts things into real perspective. It is not a get rich overnight thing (although that can happen in those very rare moments) but a consistency and systematic thing.

Tinker

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“About using margin”

Two things about that:

  • better not
  • certainly not now!
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Years ago, I bought daily market data going back to 1921. This allowed me to run various scenarios to answer my own questions, such as tinkering with a safe withdrawal rate, and so forth. And I found something about investing on margin that I have never seen published, anywhere: There was no safe level of margin, not even 1%, that would not have wiped out an investor completely if trying to hold through the crash of '29 and beyond.

No safe level of margin. None.

I know. Sure. You’re going to back it all up with more money, and hold onto those stocks – as they lose another 90%. Didn’t happen. Find a story of one investor who held through the depression and beyond – on margin. There isn’t one.

Boom and bust is back, baby. Enjoy the boom. Prepare for the bust.

Cheers,
Wot

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There was no safe level of margin, not even 1%, that would not have wiped out an investor completely if trying to hold through the crash of '29 and beyond.

Not sure what you tested there, but I’d go for margin only on index investments, and obviously not at high valuations.
E.g. 20% margin on the SPX, but only after the next recession is priced in.

Not sure what you tested there, but I’d go for margin only on index investments, and obviously not at high valuations.

You might use the margin to buy the index but from the broker’s (creditor’s) point of view, your whole portfolio is backing the margin. If an unrelated stock goes bust it could cause a margin call!

Your “Advocatus Diaboli” isn’t working! LOL

Denny Schlesinger

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