How it works
- You sign with a firm approved for marginMargin buying is offered by a brokerage firm or custodian approved by the Financial Regulatory Authority for this activity, and not every firm offers it. When you sign, you acknowledge the risks in writing.
- You pay part, the firm finances the restThe financed part is a debt you owe the firm, usually with a financing cost set in the contract.
- The shares act as collateralThe shares you bought, and possibly other securities you pledge, are held as collateral for the debt.
- You repay and release the collateralOnce you repay the debt, the hold on the collateral is lifted.
Leverage works both ways
ExampleYou have EGP 10,000, the firm finances another 10,000, and you buy shares of an invented company, Negma Pharma, for 20,000. If the price rises 10%, the position is worth 22,000. After repaying the 10,000 you keep 12,000: a 20% gain on your money. If it falls 10%, the position is 18,000, and after repaying you keep 8,000: a 20% loss. All before financing costs and commissions.
Your money10,000+ financing10,000= position20,000
Price +10%
Without margin+1,000 (+10%)
On margin+2,000 (+20%)
Price −10%
Without margin−1,000 (−10%)
On margin−2,000 (−20%)
And if the price falls 30%? The position is 14,000, and after repaying the 10,000 you keep only 4,000 of your 10,000. Losses eat your money fast, while the amount financed does not shrink just because the shares lost value.
If you do not repay
Watch outIf you fall behind on the debt, the firm that financed you may sell the securities you pledged to recover its money, when the contract provides for it. The sale can happen at a time you would not choose and at a price you would not want. Read in the contract when the firm asks you to add collateral and when it sells.
Size your position before any leverage
Track your positions in the portfolio, with their current value and your gain or loss.
Check yourself
1. You have 5,000 and the firm finances 5,000. The price rises 10%. Your gain on your own money, before costs?
The 10,000 position gains 1,000, which is 20% of your 5,000.
2. What can happen if you do not repay the margin debt?
The rules allow the firm to sell the collateral to recover the debt when the contract provides for it.
Summary
- Margin buying is buying with financing from a brokerage firm or custodian approved by the FRA for margin buying.
- Leverage enlarges gains and losses alike; the amount financed does not shrink just because the shares lost value, and the financing cost is set by the contract.
- If you do not repay, the firm may sell the collateral under the contract.