There's been a lot of news in the financial press in recent months about the large amount of "margin buying" being done by investors.

What is "margin buying"?

When investors buy stock on margin, they are, in effect, borrowing money to buy stock. Investors use these borrowed funds, or "margin," to leverage their investments in stocks.

Let's say you buy 100 shares of a $50 stock. The investment would normally cost you $5000. But you have a margin account with your broker that allows you to put up half the amount to cover the $5000 investment. (Brokers are allowed to loan investors up to 50% of the purchase price of a stock.)

Of course, brokers don't loan money out of the goodness of their hearts. As is the case with any loan, you'll pay interest. An investor using margin believes that gains in the investment will more than offset the interest on the loan.

Continuing our example, say the stock rises 20% to $60 per share, giving your shares a value of $6000. Remember, however, that you didn't invest $5000, but just $2500. so what appears to be a gain of 20% on your investment is really a 40% gain ($1000 divided by $2500). Of course, the interest you paid on the margin loan will lower your return a bit. Nevertheless, from this example, you can see the power of using margin in an investment program.

Keep in mind, however, that leverage cuts both ways. What if the stock in our example falls by 50% to $25 per share? Chances are you would have been hit with a "margin call." A margin call is a demand from the broker to put up money or securities when equity in a margin account declines below a minimum standard set by the exchange or the firm.

And what happens if you can't come up with the money? The broker starts selling your stock. In other words, because of a margin call, you may end up selling stock at precisely the worst time in order to satisfy payment for the margin call.

Bottom Line: When you bet right using margin, you can win big by using borrowed funds to buy your investments. When you bet wrong, however, the penalty can be rather severe. For that reason, buying on margin is considered a risky investment strategy for nonprofessionals. Because of the high risks, BUYandHOLD doesn't allow margin buying in its accounts.