INVESTING ON THE EDGE TRADERS NEGOTIATE SLIPPERY SLOPE OF BUYING ON MARGIN.Byline: Chris Sieroty Staff Writer
Ask Lotay Yang what has contributed to the recent volatility on Wall Street, and he's quick to point to the margins.
Yang blames investors, many of them novices, who have been purchasing securities using margin accounts _ that is, borrowing money from their brokers to buy stock and using their investment as collateral.
The use of margin debt has accelerated rapidly over the past year, reflecting the overall bullish sentiment on Wall Street and the influx of new investors into the stock market.
But now that a cloud of uncertainty has returned to the markets and brokerages are calling in their loans, many of the same investors have had to sell their securities to meet the margin calls, helping to propel prices lower across nearly all indexes and exchanges.
``I think there is a misconception mis·con·cep·tion
A mistaken thought, idea, or notion; a misunderstanding: had many misconceptions about the new tax program. that margin buying is trading,'' said Yang, vice president and branch manager at Fidelity Investments Fidelity Investments is a group of privately held companies in the financial services industry. It is made up by two independent but closely cooperating companies, Fidelity Management and Research Corporation (FMR Co. in Woodland Hills. ``It is a leveraged way investors can buy blue chip stocks Blue chip stocks
Common stock of well-known companies with a history of growth and dividend payments. .''
The attraction for investors is that buying stock on margin is like having an extra line of credit, he said.
Margin works this way: Let's say an investor buys a stock for $50 and the price rises to $75. If the investor bought the stock in a cash account and paid for it in full, she'll earn a 50 percent return on the investment.
But if an investor buys the stock on margin _ paying $25 in cash and borrowing $25 from a broker _ he'll earn a 100 percent return on the money invested.
Such speculative practices have helped to drive the Dow Jones industrial average Dow Jones Industrial Average
The best known U.S. index of stocks. A price-weighted average of 30 actively traded blue-chip stocks, primarily industrials including stocks that trade on the New York Stock Exchange. from 2,500 to over 11,000 since 1992, and the Nasdaq composite index Nasdaq Composite Index
An index that indicates price movements of securities in the over-the-counter market. It includes all domestic common stocks in the Nasdaq System (approximately 5,000 stocks) and is weighted according to the market value of each listed , home to many volatile high-tech stocks High-tech stock
Stocks of companies operating in high-technology fields. , to over 5,000 earlier this year.
The downside to using margin is that if the stock price decreases, investors can experience substantial losses.
For example, an investor buys a stock for $50 and it falls to $25. If he fully paid for the stock, he'll lose 50 percent of his money. But if that same investor bought on margin, he'll lose 100 percent _ and must still come up with the money to pay the interest on the loan.
In a volatile market, investors who put up an initial margin payment for stock may be required to provide additional cash if the price of stock falls, Yang said.
Margin rules, which are set by the Federal Reserve Board, allow investors to borrow up to 50 percent of the value of their stock portfolios to purchase additional stocks.
Firms can set higher rates on top of what the Fed has decided, Yang said. Those stricter rates are known as house maintenance requirements.
Some investors have been shocked to find that the brokerage firm has the right to sell their securities that were bought on margin _ without notifying the client and at a substantial loss to the investor.
If a broker sells the stock after the price has plummeted, then the investor has lost out on the chance to recoup his losses if the market rebounds.
With the continued volatility on Wall Street, the state Department of Corporations advises investors to treat margin like any other consumer loan and use it responsibly and prudently.
Margin loans only make economic sense if investors are convinced that their stock portfolio is likely to increase enough to cover the finance charges and commissions, said Julie Stewart Julie A. Stewart is a Canadian actress.
Julie Stewart studied acting in Montreal at the National Theatre School of Canada and now makes her home in Toronto. She was the star of the Canadian television series Cold Squad. , a spokeswoman with the Department of Corporations.
Investors need to read and understand their brokerage firm's margin loan policies, she said.
``We want to advise people about the risks of margin trading Margin trading
Buying securities, in part, with borrowed money.
The buying and selling of securities in an account in which money is owed to the brokerage firm. , and this warning is part of our ongoing effort to provide investors with education,'' Stewart said.
In response to complaints that many customers have been engaging in risky trade practices such as using borrowed money to buy shares in Internet start-ups, some online firms have restricted margin lending for some speculative stocks Speculative Stock
A stock with extremely high risk relative to potential return.
Speculative stocks often have a high probability of declining in value and a low probability of experiencing above average gains. .
Brian Dorf, associate manager of public relations public relations, activities and policies used to create public interest in a person, idea, product, institution, or business establishment. By its nature, public relations is devoted to serving particular interests by presenting them to the public in the most at Datek Online, said there is a list of restricted stocks posted on the company's Web site. Those stocks include initial public offerings and penny stocks Inexpensive issues of stock, typically selling at less than $1 a share, in companies that often are newly formed or involved in highly speculative ventures.
Penny stocks are usually available for sale over-the-counter, that is, among brokers and customers themselves, as , which can be extremely volatile, he said.
``We also try to make (investors) aware of the risk,'' Dorf said.
When Datek Online lends money to an investor, the decision is made on a portfolio-by-portfolio basis, he said.
Stewart urged investors to carefully read their brokerage firm's margin loan policies and to contact their stockbroker Stockbroker
1. An agent that charges a fee or commission for executing buy and sell orders submitted by an investor.
2. The firm that acts as an agent for a customer, charging the customer a commission for its services. if they have any questions concerning the possible risks or rewards of margin investing.
Drawing: no caption (man standing at edge of ledge)
Bradford Mar/Staff Artist