- January 12, 2021
- Investor Education
Buying securities on margin is a powerful tool available to many investors, but it also comes with significant risk. As more investors turn to margin trading to seize new opportunities in a rising market, they may also be opening themselves to an increased risk that jeopardizes their portfolio.
New figures released by the Financial Industry Regulatory Authority (FINRA) show that investors have taken on more margin debt than ever before as of November 2019, with $722.1 billion on the books. The previous high was in May 2018 when margin debt was $668.9 billion; since then, margin debt had taken a downward trajectory to March 1, 2020, when it bottomed out at $479,928 before skyrocketing over the next six months. The large increase in margin trading has raised red flags for some.
Many stocks are seeing record highs over the last few months, including COVID vaccine-maker Moderna, whose stock is up more than 500%. These tempting high stock prices may be what’s driving investors to seek out margin loans from member firms for increased trading. Even though Regulation T and brokerage firms’ maintenance requirements limit investors’ ability to borrow, in a fast moving market, the value of securities often declines faster than an investor’s ability to protect his or her account.
Why High Margin Trading May Be Risky
There is nothing inherently wrong with margin trading. However, it significantly increases the risk profile in an account and can cause investors to lose significant sums of money. Sometimes, investors can lose more money than they initially deposited into their account. If the value of an investor’s portfolio drops to a certain level, it triggers what’s called a margin call. At that point, the value of the securities held by the investor isn’t enough to support what the investor has borrowed from the broker-dealer. The investor needs to deposit cash or more securities into their account or the member firm will sell enough of their securities to meet the margin call and maintain a cushion of collateral.
Some investors borrow on margin to increase their stock portfolio and have great success. Unscrupulous Financial Advisors may recommend that investors’ over-extend themselves in order to borrow more money to purchase securities in order to generate commissions. If an investor becomes over-extended, and the financial markets decline, the impact can be devastating. Firms typically inform investors of margin calls but are permitted to take action without consulting their clients if they deem it necessary to protect their interests. In other words, brokerage firms may liquidate securities positions within an account in order to meet a margin call or limit further downside risk. This can leave investors with not only a depleted account but also a significant tax liability. In this situation it’s best to contact a skilled margin loss lawyer as soon as possible, they can help you recover your losses.
Strategies to Manage the Risk of Margin Trading
Investors who choose to utilize margins as part of their investment strategy can take steps to help protect themselves. They can implement their own margin limits and hold more secure collateral. Keep close tabs on market changes and the value of investments to minimize surprises. Avoid using more for collateral than can be readily replaced if the collateral value quickly falls and maintain a cash cushion. Finally, consult with your broker to get a better idea of the potential risks and rewards of margin trading. While it can be a powerful investment tool, it may not be the best tool for advancing every financial goal.
Between March and May 2020, there were a significant number of margin calls issued when the market declined 30%. If there is a market correction in 2021, given the amount of current margin outstanding, it could have an even greater impact.
The Wolper Law Firm represents investors nationwide in securities litigation and arbitration on a contingency fee basis. Matt Wolper, the Managing Principal of the Wolper Law Firm, is a trial lawyer who has handled hundreds of securities cases during his career involving a wide range of products, strategies and securities. Prior to representing investors, he was a partner with a national law firm, where he represented some of the largest banks and brokerage firms in the world in securities matters. We can be reached at 800.931.8452 or by email at firstname.lastname@example.org.