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.
CHAPTER XVII.
SHORT SELLING
By short selling, we mean selling a stock that you do not possess, with the intention of buying it later. Short selling in general business is very common, and we think nothing of it. Manufacturers frequently sell goods that are not yet made, to be delivered at some future time. Selling stocks short is a similar transaction, except that in a majority of cases delivery of the stock must be made immediately.
However, your broker can attend to that by borrowing the stock. As explained in the preceding chapter, when the market is active most of the trading is done on margin. Your broker buys a stock for you, but as he has to pay for it in full, it is customary for him to take it to his bank and borrow money on it. A bank usually lends about 80% of the market value, but if some other broker wants to borrow this stock, he will lend the full value of it. If that particular stock is very scarce and hard to get, the lender of the stock may get the use of the money without any interest.
Therefore, there is an advantage to the broker in lending stock, and for that reason it is nearly always possible for a broker to arrange delivery of stock for you if you wish to sell short. When you instruct him later on to buy the stock for you, he will do so and deliver it to the broker from whom he borrowed it, who will return the money he received for it.
When you sell stock short and the price goes up, you will have to pay a higher price for it. Therefore, to protect himself against the possibility of losing, your broker demands a payment from you just the same as you pay margin when you buy stock.