margin

How Margin Risk Can Devastate a Brokerage Account.

WAAAAY BACK in January of 2018, I blogged about how trading on margin, even in a prolonged bull market, can have devastating results if (when) the markets dramatically decline. See, “Investing On Margin—Will Your Chickens Come Home to Roost?” I was concerned for those investors for which margin investing might be unsuitable, as the outcome can be devastating. Certainly, there are generations of new investors with a great deal of investment dollars that only began investing real money during this bull market; meaning they have never faced a down market and the margin calls that come with. This may be a rude awakening.

With the recent Coronavirus Correction (headed toward recession), it is likely that many investors that were investing using margin have suffered significant losses, AND had to sell other securities in order to cover margin calls. In my January 2018 post, I noted that at the end of November 2017, FINRA reported there was more than $627 Billion in margin debit balances in retail customer accounts, compared to $553 Billion at the beginning of 2017, more than a 13% increase in borrowing to invest in stocks (Note: A margin debit balance represents the amount of money the investor owes the brokerage firm). Two years later, at the height of the bull market, FINRA reported there was $561 Billion in margin debit balances in retail customer accounts, a ~10% decline from the same statistic from two years before. Overall, 2019 showed somewhat lower levels of margin than 2018 and 2017, so based on this alone, it would appear that borrowing to invest leveled out at the “end” of the recent bull market. However, if one were to look at the margin debit levels in 2010-2012/13, margin balances have doubled! Clearly, investors wanted to leverage their accounts by purchasing securities using margin debt. But, as the analogy for this post goes, your chickens may come home to roost amid this market correction!

While we sometimes hear our politicians scream about someone’s “chickens coming home to roost,” the origin really deals with curses and offensive words and actions that may come back to haunt you. The old adage suggests your curses and offensive conduct are like young chickens, and will eventually come home to roost–meaning your bad conduct will eventually rebound to cause you harm. Perhaps investing on margin in a bull market is an apt analogy.

Indeed, all of our accounts should be showing substantial gains in the last 12 months, as the Trump bull market continues to run. Compared to numbers one year ago, margin investing is on the rise, with more and more accounts showing increasing margin debit balances. At the end of November 2017, FINRA reported there was more than $627 Billion in margin debit balances in retail customer accounts, compared to $553 Billion at the beginning of 2017, more than a 13% increase in borrowing to invest in stocks. So is this a curse that may rebound to cause you harm? Maybe…maybe not.

Purchasing on margin carries with it significant risks, particularly in the event of a rapid market decline. Margin can, for the right situation and the experienced and sophisticated investor be a very good tool to increase returns on certain investments, particularly short term investments, but at the same time, margin can decimate an account in a declining market or when a particular investment’s value declines. When the stocks in the account decline, or even if the firm believes the overall market conditions are not favorable to margin investing, the account holder may face a margin call. The rules of FINRA and the exchanges supplement the requirements of Regulation T by placing “maintenance” margin requirements on customer accounts. Under the rules of FINRA and the exchanges, as a general matter, the customer’s equity in the account must not fall below 25 percent of the current market value of the securities in the account. Otherwise, the customer may be required to deposit more funds or securities in order to maintain the equity at the 25 percent level. The failure to do so may cause the firm to force the sale of—or liquidate—the securities in the customer’s account in order to bring the account’s equity back up to the required level. If the account holder does not have sufficient assets, they must either make a deposit of additional funds or securities, or their assets in that account, and possibly other accounts, will be sold so that the firm is not at any risk. Make no mistake about it, most margin account agreements permit the firm to sell out your investments at any time, without any prior notice to you or consent from you. Even if your broker promises you that he will call you first, such promises may not be enforceable. In the event of an acute dip in the market, your account may be sold out at the short term bottom without any prior notice.

Articles Tagged with margin

For Many That Invested Heavily on Margin, Their Chickens Have Come Home to Roost.

Investing On Margin–Will Your Chickens Come Home to Roost?