There is a lot of borrowed money out there. Even on the retail level, you can get Canadian currency for about 2.5% at Interactive Brokers, or if you’re going to borrow over a million dollars, you’re good at 1.5%. For US currency, it is currently 1.57% and 0.57%, respectively.
Borrowing money to invest makes you look like a genius when the markets are rising, but it adds a tremendous amount of pressure when things go south.
Interactive Brokers, in their most recent quarter, announced that year-to-year margin balances have increased 38%, while customer accounts grew 14%. This is not terribly dissimilar to the statistics reported by the NYSE – while they have yet to post December balances, looking at November-to-November they have a 29.6% increase in margin balances. It is significantly higher on a percentage basis if you net the margin debt with the credit balances available.
So let’s say you’ve borrowed to the hilt, and the markets experience a 4% decline and you start to feel uncomfortable about your 2:1 leveraged position. What do you trim first to avoid the dreaded margin call?
The answer is non-marginable equity. Each dollar you raise from a non-marginable stock contributes a full dollar that can go toward the minimum equity required to maintain the account. If you decided to dump one of those 30% margin stocks, you’d need to dump $3.33 of shares to get the equivalent of one dollar.
It is likely that there are a higher frequency of bargains in the non-marginable equity rather than the full margin equity (e.g. large-cap stocks) – forced liquidations have a tell-tale sign on charts which I am sure clever software programs are consistently looking for to ensure they extract the maximum amount of pain on those that are forced to sell.
Being human, however, restricts you to keeping a good quality watchlist, having done some fundamental analysis in advance to ensure you’re still not getting ripped off on valuation, and just paying attention.