I’d love to understand better the reasons for your wariness of broker margin loans, because I’ve
been sorely tempted to take one out to achieve a modest level of leverage (1.25x)
I know that a broker can raise their margin requirements fairly quickly. I read that Interactive
Brokers did that around election time (and maybe other times before) - up to 67.5% I believe. But if
I did the math right, even if they ratcheted margin requirements to that level again, it would
require a pretty substantial drop (-40%) occurring at the same time to get a margin call on such a
relatively small amount of leverage.
Am I missing something else key/critical that makes the situation risky?
Perhaps so : )
Well, first, the math is nasty.
Let’s say it’s a Regulation T account and they allow borrowing up to 50% of the value of the stock, which means 2:1 leverage.
That sounds like a lot if you’re only using 1.25:1 leverage, but it isn’t.
As you note, it would take a 40% drop. Or as I would put it, “only a 40% drop”.
But note also that it only takes a 40% drop for a single trade for their computers to wake up and sell you out if it feels like it.
They can be very aggressive, and they warn you that they may be the counterparty on the liquidation.
They’re very businesslike, but they are in the vampire squid category: they are not your friends.
And once you breach the rules, they don’t limit themselves to the a mount of liquidation that would bring you back into compliance…they liquidate as much as they like.
(As a specific example, I ran into that myself–they liquidated $79400 worth of positions because of a margin loan of $684 in an account I wasn’t watching, with zero notice or even notification at the time.
That entailed a $48k realized loss, and the value of those liquidated positions was up 84% by the time I learned of it)
Plus, on top of all that, they can simply change the leverage limit at any time, with a few minutes of notice, and they have done so in the past.
They could call all margin loans, completely, any time they want.
So trying to following the rules is no help–they can change without warning.
Plus, when the rules do change, it’s generally during a market panic and those aren’t the prices at which you would want to be a forced seller.
So, in short–
- Prices can do anything, short term.
- Rules can do anything, any time.
Either one of those would be sufficient to rule out using broker margin loans.
The Blanche Dubois approach to investing is not one to be recommended.
And if all that weren’t enough, try reading all the rules on Reg T margin and portfolio margin, intraday and end-of-day.
If you understand them all, and they haven’t changed by the time you finish reading, you’re smarter than I am.
These agreements can be pretty tricky—at one point I was considering using contracts for difference (CFD).
I think maybe those are prohibited for US persons, not sure.
Basically it’s like single stock futures contracts that never expire: you pay interest on the “borrowed” amount from day 1 even if you have a cash balance.
In any case, I wanted to know what the actual rules were, so I asked for a copy of the actual contract implicitly referred to as the C in CFD.
Back and forth I went, over a period of weeks, and all they could say was that in effect the contract was whatever was currently the sum of their web pages that day.
I never used 'em. Even a bookie or loan shark will tell you up front what the vig is.