Margin investing is psychologically corrosive
I came across something in a video today that's an extremely good summary of why investing on high margin or leverage has a huge psychological effect:
One of the biggest issues that using margin creates is this feedback loop that primes you to do exactly what you shouldn't be doing.
Lets say you are buying stocks because you think the market is undervalued, if you buy on margin then the market goes up you can get more margin and keep buying. If you keep doing this you get into a situation where you are tempted to keep buying more when things go up, which can become too much of a temptation to resist if you don't have firm limits on the amount of leverage you will take on along with a fixed upper price you'll buy at. Similarly on the dips you start fearing getting margin called instead of seeing these as chances to buy underpriced stocks.
In other words margin investing can tempt you to do the exact opposite of what you plan to do, and it can make you absolutely miserable in the process. Margin tends to increase the greed and fear responses with people, something that you probably don't want if you are trading.
Also this hints at something else, you have to have a strategy that explicitly takes the margin being used into account, trading with margin isn't the same as trading without it1. A common mistake I see is people making some decisions about what they will buy and then assuming that since that position is a good one then adding margin will just make it better.
be very careful with trading on margin, if you have any doubts about it don't do it.
One of the ways in which things are different is that margin increases risk on an investment even if the risk of the underlying investment is unchanged. This has portfolio allocation consequences, have a look at the Kelly Criterion to get a sense of why this may be. ↩