Hi Charles,
Margin usage is currently very high… maybe even dangerously high.
I use margin, as do the Big Boys and most professional traders.
Once you’ve used up all of your available cash, you borrow and buy more up to
your margin limit.
Then if you’re crazy or crooked (think Jon Corzine) you use other
people’s money.
Notice the article’s chart – even those who dislike charting can see
what history shows when margin debt exceeds the market levels.
Mom and Pop may be on the sidelines but the Boys are borrowed-money deep
into the market.
As I mentioned a while back, the Boys are expecting that
continued market highs will entice reluctant M&Ps to sell their bonds and
join in the party, thus driving price even higher.
The question is, will the Boys run out of borrowed money before M&P
get on board?
Comments
If I undertand Margin usage, let's say I have $1,000 to invest at a brokerage (and in the market). I can "borrow" 50% more money or $500 dollars and add to my market positions so I now have $1500 invested. If all market participates were using (50%) margin the market would be leveraged (50%). That's pretty powerful stuff.
Now if the market responds positively, these leveraged particpates have help to goose the market up to 50% more due to leverage. Hard to believe that the enitre market could be 50% leveraged but theoritically it could. Maybe more depending on what markets we speak of...currency markets can leveraged 100:1 verses the equity market's 2:1.
So now, I am a bank and I am able access zero percent interest rate loans. Let's say this bank is the one that has borrowed and margined the $1500 (add more zeros if you wish). The borrowed money is invested in the market. 2/3 is borrowed from Uncle Sam at zero percent and 1/3 is borrowed from the brokerage house which I own so I get pretty good rates here too). This investment moves positively upwards as the market responds to all this new money.
I wonder what percentage of the market is "margined"? I wonder what percentge of the market is invested with borrowed money at zero percent interest rate that is then further margined?
I ask these questions because, theroetically, in a highly margined market, half the market gains could be assiosiated with "margined debt". In a zero interest rate environment, borrowed money that is further margined (borrowed margin debt) could really be significant.
Will Mom and Pop join the party so these positions can be unwound and risk tranferred at higher market levels?
Am I making any sense here?
Professional traders look at leverage in very positive ways...I came across these points on the importance of leverage.
Leverage is Good, and More Leverage is Very Good:
Leverage is Good
and,
Trading Using Leverage
Yes, you’re making sense.
Margin is what pros use – and amateurs who know what they’re doing -
to optimize their buying power.
Anyone can open a self-directed marginable brokerage account
with the required minimum initial amount of cash. Each brokerage
firm will state their minimum requirement.
You tell the brokerage house that you want to open a margin account
(or change your standard cash account to a margin account),
they send the paper work, which you don’t bother to read – just as you didn’t
read the cash account paperwork. You sign it and send them a check
or transfer the money and Bingo!, you’re a margin investor.
Of course, having a margin account doesn’t mean that you have to use
margin, it just means that that option is available to you.
And remember that if you decide to use margin, you can use a little
or as much as is available to you.
First, I highly recommend you keep your margin and cash account separate (even at different brokers). Because if the value of collateral in your margin account drops you will have to come up with additional cash in short order or they will indiscriminately sell your assets and recover their collateral.
Secondly, margin is like performance enhancing drug. It boost the returns nicely in good times. However, market turns on a dime and drops are much more swift and all those margin users who think that they are smarter than all suddenly scrambling to come up cash at the worst possible time. Some will say, they are smart and but lose your shirt. I am sure brokers have seen many of these. Margin use was very common by day traders in 2000 prior to dot com bust.
Margin is one way to lever up. The house buyer is also levering up significantly. You put 5% (or even none) to buy a house $300K and house is your collateral. The problem is that for the lender the house prices did fall so they did not get enough down/collateral to secure their losses and this threatened the well being of all financial system.
I would rather use call/put options even levered ETFs. What you lose is better under your control.
I am amazed that people are even afraid to put money on non-margined pretty vanilla blue chip dividend producing companies and yet now we are talking about margin here.