When is margin not margin?

[OldGrantonian]

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I've been buying Dow stocks for about 2 years now, and doing OK considering the economic climate.

With the markets so low, I want to try trading with a margin account, using only Dow stocks for safety (initially).

I live in the UK. As preparation, I have set up a separate bank account in the UK to ensure that I can meet margin calls even if the prices of all my stocks drop to $zero.

I would be grateful if someone could answer the following question.

Scenario 1:

1) Assume that I open a margin account with $2,500 cash. I believe that this gives a "margin buying power" of $5,000.

2) I then buy $5,000 of stock.

3) Assume the stock doubles in value, and I sell all the stock.

4) According to all the web articles on margin, I make a profit of 4 times the initial cash outlay. Because I receive $10,000, but I only paid $2,500 in cash.

Scenario 2:

1) Assume that I open a margin account with $5,000 cash (double the amount of Scenario 1). This now gives a "margin buying power" of $10,000.

2) I then buy $5,000 of stock (as before).

3) Assume the stock doubles in value, and I sell all the stock.

4) As before, I receive $10,000.

So, my question is. Do I still make a profit of 4 times? Or is it only a profit of 2 times, because there was enough available cash initially to buy the stock?

In other words, does the broker take the entire $5,000 in cash out of my account? Or does he only take $2,500 cash and lends me the other $2,500?

I'm sorry if I've used a lot of words to ask one question, but I want to be absolutely sure.
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[Rhody Trader]

Scenario 1: Your profit is $5000. Final value is $10,000, less your initial investment of $2500, less the margin loan of $2500, is $5000. This means you end up with $7500, so you've trebled your account (7500/2500).

Scenario 2: Your profit again is $5000, meaning you end up with a $10,000 account as before (note that you don't actually use any margin in this case). Since that's on a starting account of $5000 you've double your money (10,000/5,000).

 

[OldGrantonian]

.Thanks Rhody Trader for your very clear response

I agree with your assessment of Scenario 1.

note that you don't actually use any margin in this case

You've confirmed something that I've long suspected (but is not actually mentioned in the articles I've read). If you have sufficient cash in your account to buy stock without margin, then no margin is given. To take advantage of the margin, you must buy MORE stock than your "margin cash available", up to the value of your "buying power".

Before I figured that out, my plan (for safety) was always to keep plenty of cash in the margin account in order to cover margin calls that had not yet been made.

The reason for that is I live in the UK, and I'm worried that cash transfers to the US might take longer than the mandatory "3 business days" to cover margin calls.

I want to use margin because I believe that the market is low and I want the leverage, not because I need to borrow money.

Now, I need to think again. Maybe I should open an online bank account in the US, and use that to meet margin calls.

I would be grateful for any comments.
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[FarQuinnell]

when it's margout.