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Buying on margin makes profits better, losses worse

Q. Although I have never purchased stocks, I am getting ready to start. My two brothers are active in the stock market _ one much more so than the other. My brother who buys and sells stocks frequently says the way to make money in the market is to "trade on margin." My other brother lost a great deal of money in the 1987 market crash and says buying on margin greatly increased his losses. Exactly what is margin? Is it as dangerous as my second brother contends?

A. The quick answer to your second question is a resounding "YES."

When you buy on margin, you put up only part of the purchase price and borrow the rest through your broker. The "margin requirement," set by the Federal Reserve, currently is 50 percent. That enables you to buy more shares with less money. But it also increases your risk.

Let's say you buy 100 shares of XYZ stock at $100 per share _ $10,000 worth _ on 50 percent margin. You must deposit $5,000, plus commission on the $10,000, with the broker.

If XYZ's market price rises to $110, your shares are worth $11,000. At that point, you have a $1,000 "paper" or "unrealized" profit. That's a 20 percent gain on the $5,000 you invested. If you had bought in a cash transaction and paid $10,000, your gain would be only 10 percent.

However, if XYZ falls to $90, you have a 20 percent loss on the margin transaction _ double what you would have had on a cash transaction.

Margin works great when stock prices are rising. But it can be disastrous in a falling market. Your second brother and many other people had that lesson driven home in the '87 crash and more recently when the Persian Gulf crisis sent stock prices tumbling.

Q. You advise readers who have disputes with brokers to take their cases to customer-broker arbitration. Without my knowledge, my broker put a great deal of my stocks on margin. Do I have recourse? If so, how do I go to arbitration?

A. You have a good case, if you did not give the broker "discretionary power" over your account _ to do things without your specific approval _ and the customer's agreement you signed with the brokerage does not permit margin trading.

You can enter arbitration through any of the stock exchanges on which the brokerage is a member. More than 90 percent of all arbitration cases are handled by the New York Stock Exchange, 11 Wall St., New York, N.Y., 10006, and the National Association of Securities Dealers, Two World Trade Center, 98th floor, New York, N.Y. 10048.

If the brokerage is a member of the American Stock Exchange, 86 Trinity Place, New York, N.Y., you probably can use the American Arbitration Association. A clause in the American Exchange Constitution permits that, but some courts say no. The legal battle rages on.

The American Arbitration Association has 35 offices around the country. If you can't find one in your phone book, contact the association's headquarters, 140 W 51st St., New York, N.Y. 10020. Many observers feel investors do better with the AAA.

William Doyle welcomes written questions, but will be able to give answers only through the column. Address questions to William Doyle, King Features Syndicate, 235 E 45th St., New York, N.Y. 10017.