Trading on margin acceptable risk?

Barry_Bear

An online tutorial on margin it gives the following example:

Assuming the brokers Maintenance Margin requirement is 25%.

Client puts up $12,500 of his own stock/assets as his initial equity.

Client then borrows $12,500 to trade on margin

Client buys 100 shares of ZZZ at $250

Client now holds $25,000 in stocks and his maintenance margin is $6,250 (calculated as 25% of holdings)

Client has $12,500 in equity (i.e. assets in excess of borrowing) so the $6,250 maintenance margin is more than covered.

Price of ZZZ falls to $150

Client now holds $15,000 in stocks with a maintenance margin of $3,750 (25% of holdings)

Client's equity is now $2,500 ($15,000 less $12,500 borrowed) which is less than the maintenance margin.

Client faces a margin call for $1,250.


The example has the client trading on 2:1 so facing a margin call when his investment declined 33%, and they borrowed against and purchased a single stock.

Using the same criteria if margin borrowing is limited to 50% - 40% of the initial equity stake, then the investments would have to fall 67% - 73% before a margin call is initiated. If the investment is a global index fund (iShares, Vanguard so widely trades and liquid), then the risk of a forced margin call sale would appear quite small. Unlike individual stocks, a broad global market fund is less risky and volatile. Obviously this is not saying global stocks could never fall 67 - 73% (1929 and 2000) but in both cases over weeks or months, never as a flash crash and without time to add cash to the account to maintain margin.

Has anyone here used margin conservatively in this way, any views on this level of risk?  

moneysavinghero

Not sure whether there is anywhere that you can trade index funds on margin.

Barry_Bear

Really? If they are widely traded/liquid, why shouldn't they be acceptable as collateral? With IB after that you can use the margin for any purpose, even withdraw the cash I think.

Blue_Sky

What interest rate do IB charge for trading on margin, do they vary the interest rate depending on the size of your account and on the assets you are trading?

bostonerimus

Debt (except a mortgage) is something that only the rich can afford. Only fools borrow money to gamble. Some fools make money, many will lose money. 

Barry_Bear

Deleted_User said:

Barry_Bear said:

Using the same criteria if margin borrowing is limited to 50% - 40% of the initial equity stake, then the investments would have to fall 67% - 73% before a margin call is initiated. If the investment is a global index fund (iShares, Vanguard so widely trades and liquid), then the risk of a forced margin call sale would appear quite small. Unlike individual stocks, a broad global market fund is less risky and volatile. Obviously this is not saying global stocks could never fall 67 - 73% (1929 and 2000) but in both cases over weeks or months, never as a flash crash and without time to add cash to the account to maintain margin.

Has anyone here used margin conservatively in this way, any views on this level of risk?

If you would be holding cash that could be used to meet margin calls, why use margin in the first place?

I think you will find that IB have the right to change their margin requirements in response to market conditions, so you cannot rely on their current requirements remaining as they are through a massive crash.

You also can't rely on the timing of future massive crashes ressembling earlier massive crashes.

If the aim is simply to juice your returns by buying a slightly larger holding in global equities than you have the cash to buy, I don't think it's worth it.

Some (relatively rich) people might use margin as a temporary way to raise capital for a specific purpose, e.g buying a hosue before selling the previous one. Arguably that makes more sense, though it still seems like unnecessary risk-taking to me.

No it wouldn't be cash - the collateral is all the assets held in the account, which is essentially global equity index trackers. That's where the leverage comes from, so instead of holding, say £100k in equities, you borrow say, £20k on margin and have £120k invested. 

wmb194

What's the interest rate vs expected returns? Buying shares with leverage, even non-racy ones, is nothing new and some pretty boring investment trusts do it. One of the lessons of the Wall Street Crash was not to overdo it, though, and they typically won't go beyond a gearing of 15%.

benbay001

I think everyone on here will council you against using margin.

But surely even you can see the extreme risk of someone who is watching trading tutorials going out and leveraging their investments?

As for investing in a global ETF using leverage surely the interest rate will exceed the historical returns of global stocks (8%?)

Old_Lifer

Fine if everything goes as you hope.

But what if the investment doesn't go up but goes down instead ?   It may be depressed for some time if it recovers at all.  

steampowered

Deleted_User said:

Some (relatively rich) people might use margin as a temporary way to raise capital for a specific purpose, e.g buying a hosue before selling the previous one. Arguably that makes more sense, though it still seems like unnecessary risk-taking to me.

lol. Use of leverage in investments is completely standard practice for HNWs.

Leverage is probably a big component of your pension portfolio - most private equity deals are leveraged, and private equity funds form a significant component of pensions.

There is nothing inherently wrong with leverage. It increases your risk, it increases your returns. Up to you what risk profile suits you. As simple as that.

Thrugelmir

steampowered said:

Deleted_User said:

Some (relatively rich) people might use margin as a temporary way to raise capital for a specific purpose, e.g buying a hosue before selling the previous one. Arguably that makes more sense, though it still seems like unnecessary risk-taking to me.

lol. Use of leverage in investments is completely standard practice for HNWs.

Clever people use other other peoples money not their own. Complacency towards leverage is simply a result of the historically long bull market.