How to destroy a good night’s sleep
Margin is particularly troublesome for optimistic investors. For every dollar of stock you own, your broker will “let” you borrow up to 50 cents to buy more shares. While 100 shares of a company sounds good to you, 150 shares, putting down the same amount of your savings, sounds like a bargain. Of course, there is interest to pay on the loan, but the optimist reasons that the inevitable rise in the stock price will more than compensate for the interest and will accommodate an easy repayment of the loan when necessary.
In practice, though, things often go quite differently. Should the company temporarily swoon, you will get a call from your broker advising you that the loan is now due and you need to either come up with more cash or he will sell out your shares, at a loss, and cover the margin. Now a particularly optimistic type will find more cash, buy more shares, and set himself up for an even bigger fall. Many optimists have lost their life savings from a series of these episodes. Lawsuits inevitably follow.
In particularly bad markets, you are more likely get a call stating that the matter has already been taken care of and you now own only 50 shares of this company, but you no longer owe the broker a dime. This may be fortunate as it avoids the opportunity for you to put up more of your cash. However, should the company immediately recover and soar, lawyers will argue for you in court that you were not given proper notice and an opportunity to cover the deficit, which you certainly would have done.