By Joel Nanton

Many people wish they could pay cash for everything they wanted. But, ironically, those that can are the ones that borrow, use some form of credit or somehow get someone else to pay for what they want.

These people are tapping into an ancient science that enables one to use a relatively small amount of force, effort or resources to move a huge object.

It is called leverage. Almost all successful individuals and corporations use it to their advantage. And even those who have managed success without it would agree that their achievements may have been accomplished much faster, if definitely not easier, with it.

“I would rather earn one per cent of the efforts of 100 people than 100 per cent of my own efforts,” J Paul Getty, billionaire and oil magnate was once quoted as saying.

When it comes to active trading on developed markets, leverage is a powerful weapon that can blast you to super profits, once you are trained to use it.

Stocks can be bought or shorted without forking out the full cost from your own account.

In the United States markets, most brokers offer you up to four times intraday leverage or margin as it is more popularly known and two times overnight.

So, in essence, if you have $5,000 in a margin account you are actually allowed to spend as much as $20,000 to purchase stocks during the trading day. If you want to hold the stocks overnight, however, the total value of the securities you hold must not exceed $10,000 or two times margin. If it does then you would be subject to a margin call from your broker.

A margin call is essentially a request to either put more money into your account by a certain deadline or reduce the value of the securities held by selling some stock. Either way, the goal is to bring the total value of the stocks held to the stipulated margin requirement. If you don’t the broker usually liquidates some of your securities and impose certain restrictions on you for future trading on margin.

The great thing about trading on margin, something not offered by the local exchange, is that it gives you more purchasing power which can be used to buy or short quality stocks that may have been out of your price range given the size of your capital. But even better, it allows you to exponentially grow your profits.

Think of spending $1,000 of your money to buy 100 shares of ABC company and the stock price increases by ten per cent intraday (I’ve seen stocks double in value within one day). It would mean that you made $100 profit and your money grew to $1,100 by the end of the day.

If you used four times margin you would have spent $4,000 and bought 400 ABC shares. The same ten per cent gain would have given you a profit of $400 but your money would have now grown to $1,400. That would mean that a ten per cent move on the stock actually gave you a 40 per cent gain using margin.

A very attractive proposition given that if your begin to trade currencies on the Forex market some brokers give you up to ten times margin.

But be warned.

Trading using leverage or margin is like the proverbial two-edged sword—it can cut both ways.

Simply put, the best of times to be fully margined is when the trade is going your way. The worst of times is when it is not.

Think of the same ABC scenario, this time with a 20 per cent move against you.

Where you would have lost $200 of your money which would have reduced your account size to $800, on a fully margined trade you would have actually lost $800 reducing your account value to $200. And that is painful.

The regulators have set a number of stipulations, restrictions and requirements for margin trading with some stocks not even “marginable” meaning you simply have to buy it cash only.

One of the reasons given was that in a prolonged down market, investors selling to meet margin calls added to the downward pressure on stocks. Reminds me of the local scenario where, those in the know attribute the downward pressure on the local exchange mainly to selling or lack of buying by institutional investors who have been forced to abide by a recently revived archaic regulation.

Despite the pitfalls margin trading opens a world of great opportunities. The key, however, boils down to the discipline of the trader. But that’s another commentary.