The phrase “just because you can doesn’t mean you should” applies to almost everything in your life…

Just because you can buy an expensive house doesn’t mean you should. Just because you can skip work today doesn’t mean you should… The list goes on.

This is especially true in investing and trading, where a too-risky strategy could easily wipe out your portfolio.

As I’ll show you, too many investors are making this mistake today. And the consequences could be disastrous…

The simple definition of “buying on margin” is investing with borrowed money from your broker.

Like a mortgage loan where the house is collateral, the securities you buy in a margin account are the collateral. And, like any loan, you’ll have to pay interest on the money you borrow.

Buying on margin can be lucrative, and relatively safe – if it’s done right. For example, I’ve told my readers for years about how to use margin with option selling to generate safe and steady income.

But many investors don’t fully understand how to use margin properly… or what the risks are.

Let me walk you through an example…

A trader has $20,000, and he’s got a gut feeling that shares of company ABC will shoot up over the next few months. He decides to use margin to buy shares, borrowing $20,000 to try and boost his returns.

This trader can purchase double the amount of ABC than he could using a cash account…

Here’s what can happen if the trader is right and shares of ABC shoot up from $100 to $150 a share after six months…

The benefits of using margin are clear. You can make a lot of money if the market cooperates and the stock goes the way you want it to.

But that’s not usually how it works out…

Here’s what can happen if the trader is wrong about ABC. In this scenario, ABC’s share price tanks from $100 a share to $50 a share after six months…

Using margin, you can easily lose more than 100% of your investment.

No matter what happens, you have to pay back the margin loan – even if the stock goes to $0. A margin loan is just as binding as a loan from a bank… It must be repaid in full.

If you buy on margin and the stock suffers a steep and sudden decline, your broker may issue what’s called a “margin call.” This is where you’ll have to come up with the money to post the minimum amount your broker requires to cover potential losses, which can be up to 100% of what you borrowed.

If you’re unable to meet a margin call, your brokerage can sell your stocks without notice to meet this requirement. If this happens, you can often lock in some bad losses during a market downturn.

After reading all this, you might be surprised by just how many investors are buying stocks on margin today…

According to the Financial Industry Regulatory Authority (FINRA), investor margin debt hit an all-time high in May at $669 billion.

Folks have been taking on record amounts of risk. And that’s worrisome. It means when the downturn finally comes, it could be among the worst we’ve ever seen… When stocks bought with borrowed money fall, it leads to more selling and a faster, more brutal decline.

I believe it is important to eliminate any risk you can at the tail end of this decadelong bull market.

So if you haven’t yet, add some safe, income-generating assets and “chaos hedges” to your portfolio to prepare for when the good times end.

And if you’re currently trading on margin in your own account, my advice would be to stop doing so now… especially if you’re a less-experienced investor, or if you’re close to retirement.

In both cases, your top priority should be to keep your capital safe.

Here’s to our health, wealth, and a great retirement,

Dr. David Eifrig

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Source: Daily Wealth