Most people who trade in stocks buy on margin. The ordinary minimum
margin is about 20% of the purchase price, because banks usually lend
about 80% of the market value of stocks.
If you put up 20% of the purchase price of your stocks with your broker,
he has to pay the other 80%, but he can do that by borrowing that amount
from his bank, and putting up the stock as security. In this way brokers
are able t
handle all the margin business that comes to them, as long
as money can be borrowed. Of course, there are some stocks that are not
accepted by banks as collateral for loans, and you should not expect
your broker to sell such stocks on margin. In fact, if he offers to do
so, it looks as though he were running a bucket shop. See Chapter XVIII.
Many people think that buying stocks on margin is gambling and that
people should not do it for that reason, but buying on margin is done in
all lines of business, although it may not be known under that name. If
you bought stock outright, but borrowed 80% of the purchase price from
your banker to complete your payment for it and put up the stock with
him as security, you would be buying on margin just the same.
In like manner, if you bought a home and paid 20% with money you had and
borrowed the other 80% of the purchase price, you would be buying a home
on margin. The principal difference is that when you buy from a broker
on margin, one of the conditions of his contract is that he has the
right to sell your stock provided the market price drops down to the
amount that you owe on the stock, whereas if you borrow money on a home,
it is usually for a certain specified time and the lender cannot sell
you out until that time expires. However, in principle, there is very
little difference between the two transactions.
Most margin traders do not put up sufficient margin. If you put up only
the minimum margin, your broker has the right to call on you for more
margin if the price of the stock declines at all. Unless you are fully
prepared at all times to put up an additional margin when called upon,
you should make smaller purchases and put up a heavy margin when you
buy. The amount of margin depends upon the transaction, but we advise
from 30% to 50%, and at times we advise not less than 50% margin on any
purchase. In fact there are times when we advise not to buy stocks on
margin at all.
Those who wish to be entirely free from worry should buy stocks when the
prices are very low, pay for them in full, get their certificates, and
put them away in a safe deposit box. However, when stocks are low the
risk in buying on a liberal margin is very small, and the possibilities
of profit are so much greater, we do not see any objection to taking
advantage of this method of trading.