Booyah Breakdown: Margin Madness

Close your eyes and imagine, for a moment, that you're in Las Vegas.

You're at the blackjack table. All is well, but your luck has turns, and now you're running out of money. But you still believe you're going to hit it big, so you borrow $100 from your buddy.

You ante up, the dealer gives you a card and as Lady Luck would have it, you've bust. You lost, the dealer won and you shake your head in disgust. Not only did you lose all of your own money, but you lost your friend's too.

Basically, you borrowed on margin and lost.

Buying a stock on margin is much akin to gambling in Vegas. The biggest difference is that gamblers with margin accounts generally wear suits and don't have burlesque girls offering them cocktails all day.

On "Mad Money" last week, Jim Cramer railed against margin investors, suggesting that the practice creates artificial demand. He said that the single most important indicator of the market is how much margin debt is in play -- a high level is bad, while a low level is good.

Cramer's warnings about margin debt prompted many reader emails asking for more information about this risky bet and its effect on the market. Booyah Breakdown is here to explain the gamble.

Understand the Casino

First, let's tackle the practice of how margin buying works.

To buy a stock on margin, an investor needs to ante up a minimum of $2,000 to establish a margin account, though some brokerages may require more.

The general margin rules say you can only borrow up to 50% of the stock's purchase price. But the actual amount you can borrow from your broker will depend on the balance in your account. The more you deposit, the more you can borrow.

To watch Tracy Byrnes' video take of this column, click here