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Investing Finance And The Associated Risks

In the past few months, the volatility and downward trend of the investing market has caused traders and online investors alike to lose very large amounts of money not to mention sleep.

For those traders who were prepared for such an eventuality, they lost very little of either. They would have lost around 5-10% whilst the average trader lost in the vicinity of around 20% if not more.

The average online investor was drawn to the last "Bull Run" like moths to a flame. Unrealistic expectations of fast money was combined with the influence of media hype which is prevalent in a high flying share market.

Leveraging through margin loans

Many investors have for quite a while been turning to Margin Loans for investing finance. They are easy to set up. The paperwork is minimal as is the setting up costs. So you can be up and running in less than a .fortnight.

The average amount borrowed is usually around the $100.000 for which the potential trader has to put forward a fifth. In this case $20,000.But you can buy up to the full amount of the loan i.e. $100, 000 worth of stock. This is called leverage. Leveraging is a double edged sword, you can make good profits but you can have big losses as well.

The average online investor who decides on a margin loan as a guaranteed quick way to make money invariably has neither the experience nor the knowledge necessary to cope with a sudden downturn in the stock market when it occurs.

Using the latest downturn in the markets as an example where share prices dropped downwards drastically in the region of at least 20%.Investors who had margin loans of around $100,000 suddenly had a paper loss of $20,000

When this occurred they were placed in the dilemma of either putting in more money or a margin call to buy more shares. In a lot of cases being borrowed to the hilt they were unable to do either.

Their online stocks had to be sold at a loss. Other traders in the same boat had to sell their stock also. With a flood of shares hitting the markets all at once share prices were forced down even further. This caused further panic selling. In some cases investors were left with no share portfolio at all and still owed money on their margin loans. Not a nice position to be in.

Minimising risks in a downturn

An astute online investor or trader should follow certain rules to make sure that in the case of a downturn in the market, losses can be kept to a minimum.

The first thing to remember is that the only security you have is the shares themselves. You have to maintain a margin between the amount you borrowed and the current value of the shares. This is called Loan to Valuation Ratio or LVR.

If the market falls below your LVR you then have the choice of putting more money in or buying more shares. To bring up your LVR back again. Of course if you cannot do either then your lender will force you to sell all or part of share portfolio.

It is a good idea to have a diversified portfolio which covers several areas as it is invariably one area that is hit the worst. Another option is to start off with a conservative LVR in place.

Another strategy is to have an unused "Line of Credit" option in position. This will give you investing finance quickly if the need ever arises.

One final option is to have "Stop Losses" or conditional orders in place to so that you can minimise any losses to 5-10% depending on the percentage you choose. This also has the effect of locking in any profits that you may have made prior to the market downturn.

Also remember the lender also charges interest on average in the 10% area per annum. That plus brokerage has to be taken into consideration as well as capital gains tax. All of which eats into your profit margin.

So if you decide that a Margin Call is the way to go then make sure you are aware of the pitfalls that can trap the unwary investor.

Using the Debt Financing option

Imagine for a moment that you are a successful small business owner employing a small number of staff and enjoying the profits rolling in. So why would you share these profits with literally thousands of people?

The answer is simple. In order to grow, a company needs to either go into debt or sell a part of the company in order to raise money. So you can either finance that growth by borrowing from the bank, or by issuing bonds. This is called debt financing. So while you own 100% of the company, you owe a lot of money.

Selling company stock for investment financing

To raise funds you could sell stock in the company and avoid interest payments and loan repayments. The assumption here is that the shares will be worth more some day. Of course, now these new shareholders can lay claim to the assets and profits of the company. This is called equity financing.

Eventually investing finance has to be carefully considered as part of your overall strategy. Weigh the risks versus rewards, obtain expert advice and negotiate a deal that suits your individual needs. Eventually success or failure rests on your decisions.