2. Margin buying is a way of spending more money
than one actually has on hand on an investment.
This is done by putting a smaller investment down
as collateral, and then borrowing money from the
broker to make up the rest of the cost of the
stocks.
Margin buying can be an excellent way to make a
lot of money off of a relatively smaller amount of
initial capital but it can also result in some pretty
devastating losses.
3. Example
Imagine we are purchasing a stock for $100, and we
are buying it all with our own money. The price of the
stock then doubles, leaving our stock worth $200. We
have just made a 100% return on our initial
investment, and a profit of $100.
Now imagine we only have $25, so we purchase $100
worth of stock using margin buying, with a $75 loan
from our broker. The stock price doubles to $200, so
our return is actually 700%, minus the $75 plus
interest we owe to our broker. So off of an initial
investment of $25, we've made nearly $100, or almost
quadrupled our initial investment.
So margin buying can be a wonderful shortcut to
reaping large returns.