Buying “on” margin
Buying on margin is one way that investors use leverage to increase a possible return on investment. Leverage is a great way for the investor to magnify gains however it comes with great risk. While you can magnify your gains, you can also greatly magnify your losses.
In order to buy on margin, you must first open a margin account with a brokerage firm. The broker lends the investor cash in order to purchase financial securities. This is in the form of a loan and if the value of the security invested in drops then the investor is required to deposit more cash into his or her account, or to sell the stock or a portion of the stock or other financial security. Basically, when buying on margin you are investing with your broker’s money in attempts to gain more of profit than you would have otherwise gained if you used only your own money.
The initial payment made to the broker for the asset being purchased is what buying on margin refers to and this collateral is referred to as the maintenance margin. In other words, the maintenance margin is the minimum amount of equity that must be kept in the margin account to prevent from receiving a margin call. A margin call occurs when the value of the margin account decreases below the maintenance margin determined by the broker. It is the demand by the broker that the investor deposit more equity into the account or to sell off some assets. The minimum level that is required is about 25% of the total market value of the securities in the investor’s margin account. Some brokerage firms will charge percentages closer to 30 and 40 percent.
While margin buying is risky, the advantage is that you can buy up to twice as much stock as you originally could with just the cash in your margin account. This means you can potentially double your profits! The downside is that your broker can sell off your securities if the price declines. If this happens then you are unable to partake in any future rebounds that would occur if you were trading from a purely cash position.
Investors must weight the advantages and disadvantages of buying stocks on margin and decide if this is a strategy that they are comfortable with. For some investors it is too risky, however many investors utilize this leverage strategy and find it very beneficial.
Why is it important to have margin capabilities or option leverage when using candlestick analysis? For the simple process of taking advantage of favorable probabilities. If you know the probabilities are in your favor every time you make a trade, you will want to have as much accessibility to purchasing power as possible. The results of candlestick signals have proven to produce a statistical favorable result throughout the centuries. Obviously, if they didn’t, we would not be studying them today.
The expected results of a price pattern or signal confirmation provides a very big advantage to the candlestick investor. It allows for the ultimate high profit/no risk trade. Let us repeat that statement, high profit/NO risk trade.
As always, when somebody tells you there is no risk in an investment transaction, it is time to run like a jack rabbit. However, if you understand how to develop a no risk transaction, you will have discovered a simple trading strategy that put all the investment information found in candlestick signals and patterns to the ultimate profitable use.
This past weekend the Candlestick Forum presented a two-day option trading program utilizing candlestick signals. It stressed the utilization of the correct option strategy to the correct trade patterns. Each trade has risk. What if the risk factor was eliminated before the trade was completed? This is done by utilizing the information conveyed by expected results of a pattern. When analyzing a price pattern and viewing the confirmation of a pattern, what happens to the probabilities? The probabilities are greatly skewed in favor of the expected results. When a trade is executed based upon that information, the risk factor is greatly diminished. The expected results makes the trade a high probability situation.
The Staggered Spread dramatically changes the dynamics of a profitable trade. It has the capabilities of dramatically decreasing and more importantly, completely eliminating risk from a transaction. This can be done by strategically executing a spread option trade. As illustrated in our recommendation today on POT, the chart pattern showed a potential breakout through a resistance level. There are two simple methods for a breakout. One can be the price moving up strong through a potential resistance level. The other is a gap up through that resistance level. A gap up through that level usually creates a strong price day.
POT
With that knowledge, a risk-less transaction can be put in place. This morning, POT gapped up through the resistance level. The first leg of a spread pattern was put in place on the open. Buying the November 105 calls at $2.60. selling the November 110 calls for $1.20 would ‘have made’ the net cost $1.40. $1.40 to end up as five dollars if the price of POT closes above $110 at expiration day fits in to the parameters of making a three to one return on a spread.
But there is a more profitable trade situation! Buying the November 105 calls on the gap up open for $2.60 would have opened the first half of the staggered spread. What were we expecting if the price gapped up through the resistance level? A strong price move. That anticipation would now hold the other half of the spread from being executed until the end of the day. As seen in today’s price movement, what was expected after the gap up through the resistance level did occur, a strong price move. The end of the day would now allow an investor to sell the November 60s at a much higher price. Any price above $2.60 would make this transaction riskless.
Buying the November 105 calls at $2.60 and selling the November 110 calls for $2.60 would mean there was no money exposed to this transaction. If the price closed above $110 on expiration day, the zero money transaction now would release $500 of profits for each contract.
MOS
The longer the markets move in a slow consistent uptrend, the more breakouts will occur. An investor can control a large amount of equity without being exposed to any market risk. Take advantage of the information built into candlestick signals. Learn how to develop option trading strategies that will dramatically increase your equity without exposing your funds to losses.
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Good investing,
The Candlestick Forum Team
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