“USING MARGIN”

Over the past few weeks I’ve gotten lots of questions from FinTwit on why, when and how I use margin in my portfolio so I figured it was time to tackle the subject.

First off, let me just say margin can be dangerous and is not appropriate for most investors.

Before you even consider using margin please make sure you understand the risks including how it will accelerate your losses. This is how you dig a hole for yourself and I don’t want anyone doing that.

Being on margin means you are borrowing money from your broker/dealer to buy more stocks. Your existing “liquidation value” of your long positions + cash is serving as your collateral for the margin.

If you’re using too much margin and the value of your portfolio declines it’s very possible you could get a margin call which means you’re forced to begin liquidating positions to cover the margin call. You never want to be in this situation.

If you consider yourself a long term investor ie buy and hold then I would suggest staying away from margin. It does not make sense to add more risk and volatility to your portfolio not to mention the emotional stress that comes with it.

With regards to my own portfolio, I am always 80-100% invested and will occasionally take my account up to 50% margin which means I am 150% long.

Being 150% long means my upside is 1.5x greater but so is the downside.

Let’s just assume my account is worth $100,000. If I’m on 50% margin it means I’m borrowing $50,000 from my broker so I can own $150,000 worth of stocks. If the market pulls back and my stocks drop by 20% it means I’ve lost $30,000.

$150,000 x 20% = $30,000

Even though my account value is showing $120,000 I still have to pay back the $50,000 I borrowed on margin so the real liquidation value of my portfolio is actually $70,000. This means I’ve actually lost 30% in my account, not 20%. I accelerated the losses by 1.5x with margin.

So here’s how I use margin:
When I’m overly bullish on my positions and think they are very undervalued compared to where they should be trading in 2-3 months than I’m probably going to be on margin. Anywhere from 100-150% long depending on my confidence level.

When I’m less bullish on my positions and/or think the markets are due for a pullback and/or my stocks feel fully valued at the current time I’m probably going to be off margin and 80-100% long.

Last week before the selloff I was up to 140% in my account but I felt like things were getting frothy and were due for a pullback or another rotation into value. I began trimming my top holdings. I got down to 115% going into the Thursday sell off. Wish I had gotten lower.

In hindsight I should have been more aggressive with the trimming and gotten under 100%. I was being too greedy and for that I paid the price. I did a little more trimming through the selloff in case it lasted longer which it did. I got down to 105% coming into this week.

Unfortunately this week brought more selling in the growth stocks so my top positions continued to decline. Since I’m still very bullish on my stocks for the next 3+ months I’ve been buying the pullbacks.

I was trimming $FSLY two weeks ago at $95-99 and buying those shares back this week in the $80s and then the $70s. As a result of my adding this past week I have taken my margin back to 50% so I’m now 150% long again in my account.

If any of my positions bounce this coming week I will definitely start trimming to reduce my margin exposure. My goal is not to stay at 150% for long. I’m only using margin to take advantage of an oversold market or oversold stocks like $FSLY $TDOC etc.

In order for me to increase my margin I need to believe the upside over the next 3+ months is at least 3x greater than the downside. If I don’t believe this than the risk/reward does not justify being on margin.

IMO, the markets are going sideways for the remainder of this year or at least until we get more stimulus and/or through the elections.

I’m planning to stick w/ this strategy:
1) increase margin after pullbacks
2) trim positions to reduce margin when we get the bounces

This is the classic “buy the dips and sell the rips” = this is how you maximize your returns in a sideways market. You use the volatility to your advantage and pick your spots for being on margin but you need to know when to trim and reduce that margin or it will crush you.

I would never recommend any unsophisticated investor use margin because I’ve seen too many good people destroy their accounts by being over leveraged in a downturn.

I’m only sharing this information because I know a lot of people either use margin or have thought about using margin and I want them to understand the risks before going down that road.

Margin can be your friend in a bull market but it will be your worst enemy in bear market.

If you decide to use margin please be careful, please do your research, please use stop losses and please don’t be reckless or greedy.

If you have any specific questions related to this thread feel free to send me a message.