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Microcap & Penny Stocks : DGIV-A-HOLICS...FAMILY CHIT CHAT ONLY!! -- Ignore unavailable to you. Want to Upgrade?

To: Secret_Agent_Man who wrote (2348)	5/3/1998 3:03:00 PM
From: William Brotherson	Read Replies (1) \| Respond to of 50264

OK Folks, Here is how short selling works according to the rules. I got this by running a ferret. Margin trading involves buying securities in part with borrowed funds. Therefore, investors can use margin to reduce their equity investment in and magnify the returns of a long purchase. 2-16 When buying on margin, the investor puts up part of the required capital (perhaps 50 to 70 percent of the total); this is the equity portion of the investment and represents the investor's margin. The investor's broker (or banker) then lends the rest of the money required to make the transaction. Magnification of profits (and losses) is the main advantage of margin trading. This is called financial leverage and is created when the investor purchases stocks or other securities on margin. Only the equity portion is financed by the investor; but if the stock goes up, the investor gets all the capital gains, so leverage magnifies the return. Through leverage, an investor can (1) increase the size of his or her total investment, or (2) purchase the same investment with less of his or her own funds. Either way, the investor increases the potential rate of return (or potential loss). If the margin requirement is, say, 50 percent, the investor puts up only half the funds and borrows the other half. Suppose the security goes up 10 percent. If the investor bought the stock without using margin, he or she would earn 10 percent. However, if the investor used 50 percent margin, ignoring margin interest, he or she would earn the same dollar return with only half the funds, so the rate of return would double to 20 percent. On the other hand, suppose the stock fell by 10 percent. Without margin trading, he or she has a 10 percent loss. With trading, the loss is also doubled. Both profits and losses are magnified using leverage. (Note: Table 2.2 provides an excellent illustration of this point.) Margin trading has both advantages and disadvantages. Advantages: Margin trading provides the investor leverage and the ability to magnify potential profits. It can also be used to improve current dividend income. Through margin trading, an investor can gain greater diversification or be able to take larger positions in the securities he or she finds attractive. Disadvantages: With greater leverage comes greater risk, and this is a disadvantage of margin trading. Interest rates on the debit balance can be high, a further disadvantage since these costs can significantly lower returns. 2-17 In order to execute a margin transaction, an investor first must establish a margin account. Although the Federal Reserve Board sets the minimum amount of equity for margin transactions, it is not unusual for brokerage houses and exchanges to establish their own, more restrictive, requirements. Once a margin account has been established, the investor must provide the minimum amount of required equity at the time of purchase. This is called the initial margin and it is required to prevent excessive trading and speculation. If the value of the investor's account drops below this initial margin requirement, the investor will have a restricted account. The maintenance margin is the absolute minimum amount of equity that an investor must maintain in the margin account. If the value of the account drops below the maintenance margin, the investor receives a margin call, in which case the investor has limited time to replenish the equity up to the initial margin. If the investor cannot meet the margin call, the broker is authorized to sell the investor's holdings to bring the account up to the required initial margin. The size of the margin loan is called the debit balance and is used along with the value of the securities being margined (the collateral) to calculate the amount of the investor's margin. Typically, margin is used to magnify the returns to a long purchase. However, when a margin account has more equity than is required by the initial margin, an investor can use this "paper" equity to purchase more securities. This tactic is called pyramiding and takes the concept of magnifying returns to the limit. 2-18 An investor attempting to profit by selling short intends to "buy low and sell high." He or she just reverses the usual (long purchase) order of the transaction. The investor borrows shares and sells them, hoping to buy them back later (at a lower price) and return them to the lender. Short sales are regulated by the SEC, and can be executed only after a transaction where the price of the security rises; in other words, short sales are feasible only when there is an uptick. Equity capital must be put up by a short seller; the amount is defined by an initial margin requirement that designates the amount of cash (or equity) the investor must deposit with a broker. For example, if an investor wishes to sell (short) $4,000 worth of stock when the prevailing short sale margin requirement is 50 percent, he or she must deposit $2,000 with the broker. This margin and the proceeds of the short sale provide the broker with assurance that the securities can be repurchased at a later date, even if their price increases. 2-19 The major advantage of short selling is the chance to convert a price decline into a profit-making situation. The technique can also be used to protect profits already earned and to defer taxes on those profits. The major disadvantage of short selling is the high risk exposure in the face of limited return opportunities. Also, short sellers never earn dividends, but must pay them as long as the transaction is outstanding. Short sales can earn speculative profits because the investor is betting against the market, which involves considerable risk exposure. If the market moves up instead of down, the investor could lose all (or more) of the short sale proceeds and margin. Short sales can also be used to hedge--minimize or eliminate the risk of a transaction. In a regular short sale, the short seller borrows securities from someone else to deliver in the sale; the short seller does not own the securities. Shorting-against-the-box is a short sale made when the short seller already has a long position in the security. This is usually done to protect a profit that has already been made.