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8 August 2018
What is Margin Trade?
Simply put, it is a trade that one borrows money from brokers or the bankers to buy a stock in the stock market or a currency in a Forex Exchange. Here is an explanation videoSo What is the Danger?
Actually, there is nothing dangerous about Margin Trading. It is just a financial tool where investors can use as a leverage to buy more stocks or currencies.There is a danger only when the investors become very greedy, starting to trade margins above their means, borrowing more and more margin until they cannot pay up when the brokers or bankers initiate a "margin call".
What is a Margin Call?
A margin call happens when a broker demands that an investor deposits more money or securities so that the margin account is brought up to the minimum maintenance margin. A margin call often happen when there is a market crash and the account value falls below the broker's required minimum value.When there is a margin call, the investors are often given little time to do the "top ups". In the event that the investor cannot top up the account within the stipulated time, his brokers or bankers will have to right to dump all his stocks or currencies in the market at ridiculously low prices to recover their losses.
Why I have to worry?
Rightly, one need not worry much if one does not “play” margin trades; however, one would have to worry when the margin trades in the market are running out of every proportion with possible risk of causing a market failure. This is when margin debts will be so high to cause en-masse margin calls that will cause markets to collapse.Can Give Example?
1. The SGX’s Penny Stock Market Crash in 2014
A Malaysian businessman and his partners manipulated the market and caused the price of 3 Nos of SGX’s penny stocks; namely, Blumont Group, LionGold Corp and Asiasons Capital, to surged by more than 800 per cent in less than 9 months in 2014. A Singaporean trader by the name of Quah Su Ling took up a margin loan of a very big amount from Goldman Sash London. When the price of the 3 penny stocks fell on Oct 2, 2014, Goldman Sash demanded Quah to top up $48 million in her margin account within one and half hours and started selling her stocks. Over the next 2 days, $7 billions were wiped off from the 3 SGX’s penny stocks. Blumont and Asiasons’s share prices dropped from a peak of S$2.0 to less than 1.0 cents in weeks. This caused the SGX's penny stock market to crash. The details are covered here2. Stock Market Crash of 1929 - Buying on Margin
It was speculated that Margin trades were partly responsible for the stock market crash of 1929.What’s the Present Situation?
The following chart prepared by “Dishort.com/Advisor Perspectives” illustrated what is the present situation about Margin Trade in the US market.
From the chart, one can clearly see that the margin debts peaked and then fell in the last 2 market crashes in 2000 and in 2008. The 2000 crash occurs when the margin debts reached about 170% when S&P climbed 75% from 1997. There is 100% point difference between the margin debt and the S&P growth. As for the 2008 crash, this point difference is about 150%. Presently, this point difference is getting even larger at about 175% as at July 2018. There is no definite proof that a market crash is imminent but at this level, the risk of a market crash would be high.
How Bad will be the present Market Crash?
It is anybody’s guess. Many has speculated for a crash to happen in mid 2015 when Margin Debt was as high as 250%. But this crash did not happen and stock markets continue to ride higher after Trump was elected and promised to make “America Great Again”.The following chart will show the risk of market failure is much higher than those in 2000 and 2008 because the investors have choked up 3 times as much as credit balance to do margin trades.
(Note that the investor credit at 2008 was among the lowest because there was a liquidity crisis in 2008 where banks almost run of money. Investors must have been using their assets rather than their money to maintain adequate balance in their margin accounts.)
Why Government Did Not Ban Margin Trading?
Most Government realise the risks of margin trading but could not always control and contain it as it will affect stock market functions. China experienced the worse market crisis in early 2015 when Shanghai Composite plunged about 8% in a single day. Then the Authority was trying to clamp down margin tradings and risky lending practice used by the China’s biggest securities brokerages. The market has not recovered fully even 3 years after.In Conclusion
In the 2008 stock market crash, 7.0 trillions USD were wiped off. In the 2000 crash, 8 Trillions USD disappeared within weeks. This coming financial crisis could be even larger.Update : 12 August 2018
Is CFD a form of Margin Trade?
CFD is an abbrev for “Contracts For Difference”. Many treat it as another form of Margin Trading except the followings
1. One will need much less capital outlays because of the very high margin or leverage in the trade. For example, when one takes a normal margin loan, one will need to come up first with about 40% of the capital investment with 60% loan. For CFD, the capital investment may be just 5%;
2. The risk will be much higher due to the high leverage; one can easily lose 100% of one’s capital;
3. In CFD, there is no ownership of the stocks or the underlying assets. In normal margin trading, one still owns the rights to the stocks such as voting, dividend, corporate action etc; however, the brokers or the banks are given the right to sell the stock to recover their losses, if any.
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