The financial markets situation has its two sides of roses and of thorns. In rosy times you can borrow money from the money market to play in the stock market and win. You will also need to move from the stock market back to the money market before the thorns appear to choke your investments.

The opportunity for margin trading is normally created by low interest rates and sustainable in a rising stock market environment. You can be sure of a good deal of exposure to risk arising from changes in the same market dynamics. If you win, the reward can be big; if you lose, it can be even bigger. 

There are good and bad sides of credit and when it comes to stock market investing, you cannot really be sure on which side you are until you are completely out of debt. Because it is a shut cut to increasing your investing and earning capacity, it is well  worth the risk.

High risk, high stake

By borrowing to invest you are on a mission to using somebody else’s relatively low cost money to acquire riskier financial assets against the expectation of higher returns. Your objective is to create a bigger wealth than was possible relying solely on your own capital.

The success of the endeavour depends on the ability to create the higher capital value desired. The investment choices must be right for your capital value to be going up and not down. Because the assets are built on the foundation of borrowed money, they can only stand when the prices of chosen stocks are going up.

It’s your  bet

The providers of the credit are willing to let the money do a hard work for you but they are unwilling to put the money to the risk you want to take by themselves.  Neither will they let the risk of loss get too close to their money. They understand that you are betting that you are smarter than they are when it comes to the use of money. Well and good for you if you win but if you lose they wont lose with you. It’s your bet.

The credit will normally be structured to create a robust loss absorber for the funds provided. You will be required to provide a percentage of the total sum you want to invest, say 40 per cent. This becomes a margin of protection for the 60 per cent that is represented by borrowed funds.

Losing, you lose alone

While you are looking at the prices of stocks invested in to make your money, your creditor already has in his hands your 40 per cent contribution he requires to make his own money.  The value of your investments may go up or down but the creditor will never let it go anywhere close to 40 per cent decline. If the value of the investment drops to the point too close for comfort, they will sell your investments to recover the loan.

With competition among banks intensifying on the asset side of the balance sheet, borrowing to invest is expected to grow in popularity. But don’t be mistaken, the bank or whosoever is the lender isn’t taking the investment risk with you. The expectation that the prices of shares you are investing in will go up is your calculation. If they do, you save and grow your capital contribution. If they don’t, you lose. Whether you lose or gain, the bank will collect the principal borrowed with full interest. 

Getting it right

Before you take on stock buying credit you have to appreciate that getting it right depends on your ability to construct a portfolio of high quality assets. The money must be in stocks that will go up in price. To achieve that, you need to have a very good understanding of the stock market outlook; where it is coming form and where it is going. You also need reliable investment decision making tools to play successfully in the information driven market.

The unending dynamism of the stock market creates changes that call for different responses as well. The market is subject to innumerable forces – economic, political and others and share price behaviour depends on which forces are winning at a given point in time. The interplay of fundamental and technical forces creates up and down trends for individual stocks and for the entire

Timing stocks and seasons

The market has seasons of buy and sell and even blue chips have their down years. You must be sure at what point of a market turn you are entering. You need good information on growth prospects of companies and how the bull and bear developments around traded stocks are likely to affect price performances in the short- and medium-terms.

Playing the market with credit money is taking an already high risk endeavour one step ahead. That does not in any way suggest that you cannot take a good risk with an exceptional return at that level. To operate at that level and win however you need to first discover an opportunity. There is need for you to see something that the market isn’t seeing yet. With the superior information you take a bet and  wait. Don’t forget what the bet is - if stock prices fail, let your capital contribution go.

Without a sound information base, the risk of venturing into equities with borrowed money is nothing far from gambling. If you play the market that way and win you are just lucky.  And you certainly cannot be lucky all the time.  It is not the availability of credit that should determine your entry into stocks; it is the availability of opportunities discovered in the market.

Playing with credit is hit and run

Just as there are the best buying seasons for stocks, so also do selling seasons come and go. Because your investments are sitting on a fragile foundation of borrowed money, you cannot afford to sit tight on your investments and let the best selling opportunities pass by. You may do well as a long-term runner with your own funds but when it comes to playing with borrowed money, you need a change of orientation to a short-term player. The principle is to strike while the iron is hot.

Another rule you need to observe is to avoid staying on credit for too long. The idea of playing with borrowed money is to enable you build or enlarge your own capital stock. You definitely know what you want and when you achieve it don’t hesitate to pay off your creditors.

When you have followed a high risk route to build your investment capital, you need to reduce the level of your risk exposure to safeguard the value of your investments. If share prices fall and you lose the bet, the lender will hit and run. If share prices rise and you win, it’s also hit and run!

Mike Uzor MD/CEO Datatrust Consulting Ltd