Trading on Margin.....Stocks Vs. Commodities

Q: The question has been raised, how trading stocks on margin differs from trading commodity futures on margin. Here is the answer: Trading Stocks on Margin: Agressive investors can increase their profit potential by buying stock on margin. The maximum leverage allowed by the law is 50%. You can buy, for example, $10,000 worth of stock by only putting up $5,000. When doing this, you actually borrow the other $5000 from your brokerage firm, who will charge you interest for this loan.

A: You MAY see negative returns because of storage costs. These effects
tend usually to be dominated by price fluctuations. You may see either
positive or negative returns because due to the fluctuation in supply
and demand, the value of the commodity will go up and down.

Although my professional experience lies more in the area of fixed
i

ncome (bonds), a few observations spring to mind in respect of
trading stocks on margin vs. trading commodity futures. I apologise in
advance if these observations (from the viewpoint of somebody that
works on a bank's trading floor rather than the viewpoint of a private
investor) are already obvious to you all!

Well, there is the bid/ask spread and the broker commission, so it's an
"almost zero sum game."


And if you want to get theoretical about it, stocks are a zero sum game,
because the original issuer (the company) is "short" the stock. i.e., if
you're an entrepreneur who goes public at $20 a share and it soars to $40,
you "lost" $20 a share (well, sort of).

When we're purchasing stocks, we're buying something that actually
exists, i.e., a piece of a business. Now, instead of a company, suppose
we bought an Aston Martin for $150,000. Then we proceed to drive it off
the side of a cliff. Our $150,000 property is reduced to zero. Who
benefitted from this misfortune? Certainly not the dealer who sold us
the car (unless we buy another Aston), certainly not the insurer who has
to pay out a claim, and certainly not the purchaser who will never see
anything close to the $150K.


On the other hand, (and this happened to me) if we were short gold
futures at the time Sadat was assassinated, my short position is in the
red by thousands while the holders of long positions profited by my loss
(less commissions, NFA and exchange fees).


And that's, in my opinion, the principal difference between stocks and
futures trading.