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order to short a stock, you will need to open up a margin account with your broker, as Joe Campbell did. You’ll also need a margin account in order to trade stocks using margin. When you buy a stock on margin, it means that you are borrowing money from your broker, in order to purchase more shares of stock than you would normally be able to buy with just the cash sitting in your brokerage account. Let’s say that I have $10,000 in my margin account. Most brokers in the U.S. will allow me to go on margin to purchase $20,000 worth of stock in that account. What this means is that they are lending me an additional $10,000 (usually at some outrageous annual interest rate like 11%, which is what E*Trade currently charges) to buy more shares of stock. If I buy $10,000 worth of stock and the stock goes up 10%, I’ve just made $1,000. But if I can increase the amount of stock that I’m buying to $20,000 using a margin loan, I will have made $2,000 on the same 10% move. That will mean that my trading account has just gone up by 20% ($2,000/$10,000). Of course, if the stock goes down 10% and I’m on full margin, I will have lost 20% of my account value. Trading on margin is thus a form of leverage: it amplifies the performance of your portfolio both on the upside and the downside. When you buy a stock using margin, the stock and cash in your trading account is held as collateral for the margin loan. If the stock falls enough, you may be required to add more cash to your account immediately (this is called “getting a margin call”), or risk having the broker force you to immediately sell your stock to raise cash. Often this will lead to your selling the stock at the worst possible time.
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Matthew R. Kratter (A Beginner's Guide to the Stock Market)