Buying Stock On Margin
Americans buy many things on credit, and stocks are no exception. Investors who qualify can make a stock purchase by paying 50 percent down and getting a loan for the remainder. This is called buying on a "margin" of 50 percent. The balance is borrowed at interest from the brokerage house and the stock certificates are deposited with the broker as security. The Federal Reserve Board regulates the minimum margins, the amount that must be paid in cash as a percentage of a purchase. The minimum margins vary, depending on whether there is need to stimulate the market or curb its speculative enthusiasm.If an investor sells stock held on margin that has appreciated, the investor may pocket the profit and pay the broker the amount that was borrowed plus interest and commission. If the stock goes down, the broker can issue a "margin call," and the investor is required to pay an additional amount into the account. If the owner cannot produce cash, some of the stock is sold at the investor's loss.
Buying stock on margin gives speculators (traders willing to gamble on high-risk situations) the opportunity to extend the scope of their operations. Their available cash will buy many more shares, giving them the opportunity of making more profit and also the risk of suffering greater losses.
At times the Federal Reserve Board requires a 100-percent margin, meaning that all stock must be paid for in cash. During the 1950s, for example, the margin rate varied from a low of 50 percent to a high of 90 percent. A low rate, of course, stimulates stock buying, while a high rate discourages it.
The first concern of most investors is the safety of their purchases. If necessary they will often take lower dividends to avoid great risk. In contrast, speculators hope to see the price of their stocks go up, usually within months, or even days. They are more interested in the future of the stock than in its earning power at the time of purchase. People who believe they can outguess the market try to buy before prices rise and sell before they fall.
There is also a group of speculators known as "short sellers." A short seller is someone who invests money because he or she expects a particular stock to go down in value. This person sells "borrowed" stock, in hope of replacing it later with stock bought on the open market at a lower price. This is one of the riskiest ways of investing in the market, because the price of a stock that is doing very well may rise tenfold or more, in which case the "short" gets "squeezed" for a big loss. Selling short is governed by specific rules to prevent abuses of a type that occurred in an earlier era on Wall Street.
