At its simplest, the stock market has been very different since the start of 2020. Many thought that the market was wild on its run from 2015 to 2019, but it stands no match to this past year. In the last year and a half since the COVID dip occurred, all 3 indices are up more than 75 percent, which is bonkers. Investors have been oddly euphoric, with record volume coming from retail traders, millions of options contracts being traded daily, and lastly, the one that can come back to bite us: margin trading.
Simply put, trading on margin is very risky. It involves borrowing money from your broker to purchase a stock, with the broker financing a specific amount of the position. For example, if you wanted to buy 10,000 dollars’ worth of GameStop stock but you only have 5,000 dollars in your account, you can use margin to borrow another 5,000 dollars from your broker to fund your investment. In this example, your position is now leveraged and your profit/loss doubles. That is where things get risky as a 50 percent decrease in GameStop stock would leave you with zero capital in the investment, and possibly in debt to the broker. This is considered as a margin call, and to resolve this, many are forced to liquidate their positions, which creates a lot of selling volume.
To initiate a margin call, stocks need to go down, and this is often done with bad news. Unfortunately, global tech stocks have taken a hit in the past few weeks as sector rotation and inflation have been in investors’ minds, especially in the United States. Taiwan’s stock market is made up of many tech companies, and their index, the Taiex, is mostly weighted by semiconductor and chip stocks, which classify as tech. This comes with the fact that Taiwan announced a lockdown as COVID is starting to surge there, and vaccination numbers are still struggling. Combining all of this, the index fell 8.6 percent in the morning, inching towards correction territory in a single day. Coincidentally, margin debt has increased by 46 percent during 2021 in Taiwan as people continued to leverage their positions. On Tuesday, the index dropped by 4 percent, which caused margin debt to decrease by 45 million dollars, and with how large the selloff was on Wednesday, the number is larger. That, mixed with the fact that the index dropped extremely quickly, signals that margin calls were taking place.
You may be wondering, what’s so important about Taiwan? First of all, Taiwan plays a major role in geopolitics, so they shouldn’t be shunned off so easily. More importantly, though, is that this could play into effect in the US also. The US’s margin debt sits at a whopping 822 million dollars as many funds on Wall Street are heavily leveraged on their positions. We saw what happened with Archegos, so anything is possible. What do you think about the margin situation throughout the world?
I am not a financial advisor and my comments should never be taken as financial advice. Investments come with risk, so always do your research and analysis beforehand.