Protecting Yourself While on Margin
To protect yourself if you think the market is heading for a fall, you can buy what's called a put option, which is the right to sell a stock at a specified price within a set period of time, usually up to eight months, to the seller of the put. If the price of your stock drops enough, the put option will become more valuable. Then you can sell the option to offset the losses on your stock.
Example: In January 1999 the share price of ABC Steel is up to $80, and you believe that's too high. So you buy a put on 100 shares of ABC at $80, coming due on September 1, 1999. Lo and behold, the stock does drop to $60 on September 1. You cash in your put and collect $80 per share, or a total of $8,000 for the 100 shares. But those shares are worth only $6,000 in the market, so you've gained $2,000 minus whatever you paid for the put.
For extra insurance, you can instruct your broker to sell your shares automatically if they fall to a certain price; this is called a stop order. Choose the price at which you would no longer want to own the stock and advise your broker to sell at that level.
Then if your shares fall without your noticing, your broker will sell them and prevent your losing more money. It's extremely important to have strict rules when using margin [http://www.aboutinvestinginfo.com]. Here are a few guidelines:
Use margin only during bull markets.
Never use margin to buy in declining markets.
Have clear sell rules for each stock.
Borrow less than the maximum.
Check your stock prices daily.
Never use margin to buy more shares of a stock that is falling.
There are also some personal considerations for you to keep in mind:
Don't use margin if you can't accept the risk. The value of your portfolio rises-and falls-twice as fast on full margin.
Don't use margin if you don't like debt.
Don't use margin with small accounts. You are more likely to concentrate your holdings in fewer stocks and that makes using margin riskier.
Don't use margin for long-term investing. Slower-moving big cap stocks, which are favorites of the buy-and-hold investor, won't move fast enough to justify the interest charges on a margin loan. A big cap stock might move up 15 or 20 percent in a year, but interest charges would almost cut the return in half.
Not all securities are marginable. Stocks selling under $5 usually can't be margined. The New York Stock Exchange can set special loan limits for individual issues that show unusual volume or price fluctuations, which discourages speculation.
Finally: Never answer a margin call. If you have an account on margin and a stock declines to where you must put up more money to maintain the position, don't do it. Sell the stock. It may be painful, but the market is telling you that you are on the wrong path.
To protect yourself if you think the market is heading for a fall, you can buy what's called a put option, which is the right to sell a stock at a specified price within a set period of time, usually up to eight months, to the seller of the put. If the price of your stock drops enough, the put option will become more valuable. Then you can sell the option to offset the losses on your stock.
Example: In January 1999 the share price of ABC Steel is up to $80, and you believe that's too high. So you buy a put on 100 shares of ABC at $80, coming due on September 1, 1999. Lo and behold, the stock does drop to $60 on September 1. You cash in your put and collect $80 per share, or a total of $8,000 for the 100 shares. But those shares are worth only $6,000 in the market, so you've gained $2,000 minus whatever you paid for the put.
For extra insurance, you can instruct your broker to sell your shares automatically if they fall to a certain price; this is called a stop order. Choose the price at which you would no longer want to own the stock and advise your broker to sell at that level.
Then if your shares fall without your noticing, your broker will sell them and prevent your losing more money. It's extremely important to have strict rules when using margin [http://www.aboutinvestinginfo.com]. Here are a few guidelines:
Use margin only during bull markets.
Never use margin to buy in declining markets.
Have clear sell rules for each stock.
Borrow less than the maximum.
Check your stock prices daily.
Never use margin to buy more shares of a stock that is falling.
There are also some personal considerations for you to keep in mind:
Don't use margin if you can't accept the risk. The value of your portfolio rises-and falls-twice as fast on full margin.
Don't use margin if you don't like debt.
Don't use margin with small accounts. You are more likely to concentrate your holdings in fewer stocks and that makes using margin riskier.
Don't use margin for long-term investing. Slower-moving big cap stocks, which are favorites of the buy-and-hold investor, won't move fast enough to justify the interest charges on a margin loan. A big cap stock might move up 15 or 20 percent in a year, but interest charges would almost cut the return in half.
Not all securities are marginable. Stocks selling under $5 usually can't be margined. The New York Stock Exchange can set special loan limits for individual issues that show unusual volume or price fluctuations, which discourages speculation.
Finally: Never answer a margin call. If you have an account on margin and a stock declines to where you must put up more money to maintain the position, don't do it. Sell the stock. It may be painful, but the market is telling you that you are on the wrong path.
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