Despite the Risks, Margin Still Lures Daytraders

Trading with borrowed money is crucial for some, but crushing for others.
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It took David Arrich only a few minutes to figure out that without margin, and lots of it, his daytrading profits weren't going to last long.

A few days after hearing that

Cornerstone Securities'

clearing agent,

Spear Leeds & Kellogg

, was

clamping down on margin lending practices earlier this month, Arrich, 35, packed his bags. He's now signed on with a small

Chicago Stock Exchange

market maker where he'll continue his rapid-fire trading style, but with the firm's money.

Daytraders like Arrich have become accustomed to using margin, or borrowed money, to buy stocks. The legal lending limit is 2-to-1, which effectively allows traders to double their buying power. But a group of state securities regulators, in a report issued Aug. 9, said daytrading firms routinely

skirt these rules, dramatically increasing daytraders' buying power -- and the amount they can lose.

And while daytraders and their practices have slipped from the public's view since the July 29

shooting of nine people in two Atlanta daytrading offices, it's clear that trading stocks on margin remains a crucial, and

controversial, part of the industry.

Arrich began trading at Cornerstone last October after more than two years at

On-Site Trading

, another proprietary trading firm. At On-Site, he says, he "donated left and right" -- meaning he lost money. But the trading experience still bolstered his confidence.

'There is something wrong and potentially dangerous with controlling a few million dollars in positions intraday with $50,000 in your account.'

-- daytrader David Arrich

So at Cornerstone, Arrich says he borrowed money 10 or even 20 times his account holdings to place trades across a wide spectrum, seeking to profit off small moves in the stocks of one-half or three-quarters of a point. By diversifying across 10 different positions, Arrich could cut his losses.

"With $50,000 in the account, pretty much every day I had between $500,000 to $1 million out," Arrich says. (Cornerstone declined to comment.)

At the beginning, Cornerstone, he says, had him sign about 20 promissory notes from lenders at 18% a year, charging about $49 a day to borrow $100,000. By signing multiple promissory notes, Cornerstone was able to move money from large accounts into Arrich's account to cover the margin requirements, which require a certain percentage of equity in your account, for the trades.

But then Spear Leeds changed the rules. Without the extra margin, Arrich didn't think he could reach his goals, making $10,000 a month. With only $50,000 or $100,000 to tap into, he says, it's not impossible -- but it's a lot harder.

Still, Arrich says he wonders whether it makes sense for "guys with accounts worth only $25,000 to $50,000" to trade millions of dollars worth of stock. "There is something wrong and potentially dangerous with controlling a few million dollars in positions intraday with $50,000 in your account."

Learning from Others' Pain

Kent Hurd is a wary user of margin.

The 33-year-old Fort Worth, Texas, resident spent five years as a broker for

JB Oxford

and then

Dean Witter

before turning to trading full time about eight months ago. But his days as a broker have stuck firmly in his mind.

Clients would call him, asking to margin positions far beyond their means. When their positions faltered, they would get caught in a downward spiral of margin-maintenance requirements and margin calls.

"A lot of clients had to sell out of stock. They couldn't meet the maintenance calls," Hurd says. The pain of making those phone calls has kept Hurd from using margin aggressively, or for long-term investing.

"I use margin as a trading tool and strictly for a trading tool. You have a lot of folks who will invest and buy stocks on margin. To me, that's crazy. You'll never know when you're going to get a downturn," he says.

Hurd uses margin to "amplify" a trade. "If I can only buy 1,000 shares and I really feel good about a stock, I'll use margin to go out and buy 2,000 or 3,000," he says.

Hurd trades at an office of

All-Tech Investment Group

, which offers him the approved rate of 2-to-1 leverage. That allows him to double his buying power from, say, $50,000 in his account to $100,000.

'You have a lot of folks who will invest and buy stocks on margin. To me, that's crazy.'

-- daytrader Kent Hurd

For example, Hurd says that during the weeks ahead of

Microsoft's

(MSFT) - Get Report

fiscal fourth-quarter earnings release, he started buying the company's shares at around 83 and then sold out when they hit 95 to 97. He used leverage to double the number of shares he was buying to 3,000.

Worn Down and Out in Los Angeles

For chiropractor Larry Weiner, margin was just one part of a financially distressing experience. In February 1997, the 48-year-old Los Angeles resident started trading from home with All-Tech Investment.

Six months and about $30,000 in losses later, he quit.

"I don't know if margin helped or hurt," he says. "But I got a couple of margin calls. I had to send them money or sometimes they would do a journal from someone else's account," Weiner says. Brokerages sometimes "journal" funds, or move them, from one customer account to another in order to cover margin calls or margin-maintenance requirements.

The theory was that on a good day, he says, you could make the money back. Trading from 6:30 a.m. PST to 10 a.m. PST or 1 p.m. PST, depending on the schedule of his day job, Weiner says he averaged about 15 trades a day. Those trades were usually leveraged 2-to-1 and often involved 1,000 share lots of fast-moving stocks such as

Intel

(INTC) - Get Report

.

But over time, Weiner says his account dwindled, eaten up by what he says was a combination of factors, including high commissions (All-Tech charges about $25 a trade) and a strategy of making trades based on small fluctuations of only 1/8 point. Sometimes those trades of 1,000 shares would only be partly executed, leaving him with a random lot size like 433 shares, which can be difficult to resell because there are fewer orders of the same size.

Eventually, Weiner had had enough. He's still active in investing, but he's put himself in the hands of a traditional broker who's helping him trade futures on the

Dow

. He's even a long-term investor -- sort of. "Definitely two- or three-month positions," he says.