With the current market pullback recently, some people have got a “margin call”. They have to, either add more money or liquidate their investment (meaning sell in low price).

For those who don’t know, “margin” basically means borrow money from your broker to invest. On the one hand, using a margin can accelerate our return. On the other hand, there is a greater risk when we have market pullback, just what we had recently.

Let’s take an example: suppose that we invest $10,000. Using a 2:1 margin ratio, we can invest up to $20,000. Let’s assume that we invest the whole $20,000.

Scenario 1: Our investment goes up by 50%. Our balance is now $30,000. It means we have a profit of $10,000; so our return of investment is 100%. Remember that our original principal is $10,000.

Scenario 2: Our investment goes down by 50%. Our balance is now $10,000. Since we still “owe” our broker $10,000. we lost all of our principal money. In other words, our return is –100%.

Usually, you won’t be able to lost all of your principal when investing using a margin. Your broker usually will do “margin call” if your margin ratio dropped below a certain level. For example, if your broker allows up to 3:1 margin ratio, once your principal is less than 33% of your total investment; they will call you.

Getting a margin call is always not a good experience. Sometimes, we have to sell our investment in a very low price.

(Picture is from stock.xchng.)