Borrowing money to be able to buy more stock can be a good way to earn more money more quickly. Unfortunately it can also be a quick way to loose all your money. This is due to the fact that borrowing money will leverage both your gains and your loses.
I do not recommend borrowing money to buy stock. It is a high risk strategy and should never be recommended to anyone who can not afford to take a large loss as a result of the strategy. It does not matter how sure you feel about a certain stock. There is always a risk that you will end up losing money.
If you decide that you want to borrow money to buy more stocks than you otherwise would be able to do then it is very important that you understand the risks that are associated with this strategy and exactly how much money you can loose. It is also important that you understand exactly how much money you earn or lose for every percentage point the stock gain or lose in value. Make sure you know how much the stock can go down in value before you need provide additional security if you do not want the broker to force sell your shares.
How does it work?
Most stock brokers allow you to use your stock as security to be able to buy more stock. How much you can borrow varies between different stock brokers.
Different stocks have different collateral value depending on how well managed the company is and how volatile the stock is. Blue chips stocks generally has the highest collateral value while most penny stocks have no collateral value what so ever. A stock broker might allow you to borrow 80% of the current market value of a blue chip stock such as IBM. The same broker will likely not borrow you a single cent against a penny stocks. You will have to visit your broker to find out how much they are willing to lend you based on the stock you own.
Keep in mind that you can use stocks you have purchased using borrowed money as collateral to borrow more money. Lets look at an example. If you have USD 10 000 in a brokerage account invested in a blue chip stock that allows you to borrow 80% of the market value. In this situation you can borrow 40 000 for a total portfolio value of 50 000 (20% collateral). This allows you to earn 5 times more money than you would normally be able to earn. In other words. If the stock goes up in value by 1% you will earn 5% return on your original investment. In this case 10 000. But it only takes a 20% drop for your original investment to be completely wiped out,
I do not recommend borrowing the maximum amount of money you can borrow. If you do this you will need to provide extra collateral if the stock goes down in value. It is better to leave a little room so that the stock can go down a little without the need for extra collateral to make sure that your broker doesn’t force you to close your position early. Remember that a stock can drop temporarily even if you correctly predicts to overarching trend. A potential profitable trade can result in a big lose if you are forced to close it before your predicted result can materialize.
Know the costs
Do not stare yourself blind at the potential profits you can earn. It is important that you also consider the cost associated with borrowing money. You have to pay interest on the money you borrow. Some stock brokers offer loans with very low interest rates while others charge a higher interest rate. It is imperative that you find out exactly how much your loan is going to cost you and how much the stock is going to have to increase in value for you to break even.
Make sure it is worth the risk before you borrow the money. If the costs are likely to eat up most of the profits than it likely isn’t worth borrowing money. Buying stock for borrowed money is always a high risk venture and is not worth it unless you can expect a high return.