Brokers deal with margin issues by selling client assets. They get permission to do this from clients when you open up your account, and they can sell your assets without warning. They do this so they can cover the loan they made to you.
What they can’t prepare for very well are gaps or discontinuities in positions that can cause losses in excess of client’s equity.
A great example in the past was when the Swiss Franc decided to remove its currency floor against the Euro, and the floodgates came rushing in. This was enough to bust up FXCM and other banks were forced to take losses (in addition to Interactive Brokers taking a bit of a hit).
We have been seeing limit down situations on the S&P 500 futures and this results in trading that is relatively discontinuous, which makes it very dangerous for brokerages that give out margin.
There is plenty of evidence of people getting cleaned out of positions. You can’t really detect this in most liquid positions (the trading is orderly, albeit the price goes down), but in smaller liquidity issues, it is really obvious when somebody gets cleaned.
For example, at 10:14am today, somebody traded a few hundred shares of PPL.PR.Q today at $7.83 and $7.84. At this price, the current yield would be over 15% for four years, and the rate reset rate at present 5-year government of Canada interest rates would have been about 11.5%. This is a total outlier compared to the rest of the preferred share series.
Lest you think you would be on the other side of this trade, I have typically noticed that market makers in a lot of these instances will beat you by a penny. In the above instance, had you had an order placed at $7.90, for example, chances are the liquidation fills would have taken place at $7.91, gone to the market maker. To a certain extent you can mitigate against this by using hidden orders.
If you are lucky enough to get on the other side of these types of trades, you will do very well (assuming you don’t get cleaned out yourself later!). It is very difficult to predict where the “bottom” will be, getting close enough will still result in gains. From an absolute value perspective, the PPL.PR.Q trade (it was just a few hundred shares so there is no way one could have received it in size) should do relatively well, but who knows – the next mass sell order might be at $6!