Chapter 11

Buying on Margin

Buying on margin is a highly leveraged way to buy stocks, but it's just as leveraged on the way down as it is on the way up. It's not for amateur investors, but for sophisticated professionals with nerves of steel. My dad thought he was one, and it wiped him out.

My dad was a gambler at heart, so he sold the stock in the company he had helped to build and went to New York to really get rich speculating on stocks on margin. Unfortunately, it was 1929, and on that historic black day in October when the market crashed and Wall Street became a falling-body zone, he lost every penny.

Buying stocks on margin means you borrow money to buy stocks. In 1929, margin buying was the big reason the market had soared. All you needed was 10 percent margin money, which meant you could open a margin account with a broker and buy stocks by only putting up 10 percent of the cost of the stock in cash, with the broker loaning you 90 percent. This multiplied the investor's buying power by 10, driving the market ever higher. Fortunes were made overnight—sometimes in minutes—as a 10 percent move upward would double your money.

That meant that if you wanted to buy 1000 shares of ABC Widgets at $10 a share ($10,000), you only had to put up $1 a share ($1,000), and the broker would put up $9 a share ($9,000). If the stock went up $1 to $11, you doubled your money, because you could sell for $11,000, pay the broker his $9,000 loan, and pocket $2,000. That worked great only when ...

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