The right level of safety for Margin loans

[helloyou]

Hello,

Since I've had access to my Margin account on Interactive brokers, it's a pleasure being able to buy stock on Margin with interest rate as low as 1.5%. Gains are much higher, but losses are twice as painful.

I've been looking at risk buying on margin, and what are acceptable risks.

50% margin:
Meaning if I have 100k, I'd borrow 50k for a total of 150k to play with
If the portfolio drops by 33%, the reduced total would be 100k and any loss would start triggering margin call (ie. 50K is loan and 50K is my asset, so any further asset loss need to be covered)
If the portfolio drops by 66%. My account would be wiped out.

So, a 50% margin shouldn't be used most of the time as a 33% loss would already trigger margin call. Stop loss is mandatory to avoid tragedy. 


30% margin:
50% drop triggers margin call
76% drop wipes out the portfolio

A 30% margin could be used under some circumstances where there is a high likelihood of success. Stop loss are necessary as well


20% margin:
66% drop triggers margin call
83% drop wipes out the portfolio

A 20% margin is still higher risk even though it seems low and needs stop loss. It can however be used more regularly as a 66% market drop is much less likely than the previous situations.


10% margin:
80% drop triggers margin call
91% drop wipes out the portfolio

10% margin seems relatively safe and can be used regularly. Probably doesn't need stop loss and it's unlikely to see an 80% drop although possible.


5% margin:
90% drop triggers margin call
95% drop wipes out the portfolio

I think this one is safe enough to be used regularly and long term.


So now that I've estimated the potential margin call, I can really see that 50% margin is actually super high risk and not to be used. But a 10-20% margin on regular basis could be used when situation allows. What do you think?

[waltworks]

You're gonna shoot your eye out, kid.

-W

[MustacheAndaHalf]

10% margin:
80% drop triggers margin call
85% drop wipes out the portfolio

With 100k you borrow 10k, and have 110k invested.
An 85% drop means 110 x .15 = 16.5k
You pay off the 10k margin loan and have 6.5k left over.

I'm nit picking for an important reason: your math has to be correct when working with margin.  If you don't accurately predict what can happen in various scenarios, the leveraged losses can do a lot of damage.

For margin loans, Interactive Brokers uses dynamic risk management: they will simply sell your assets if they think the situation is too risky.  It's faster and harder to predict than a margin loan.

[helloyou]

10% margin:
80% drop triggers margin call
85% drop wipes out the portfolio

With 100k you borrow 10k, and have 110k invested.
An 85% drop means 110 x .15 = 16.5k
You pay off the 10k margin loan and have 6.5k left over.

I'm nit picking for an important reason: your math has to be correct when working with margin.  If you don't accurately predict what can happen in various scenarios, the leveraged losses can do a lot of damage.

For margin loans, Interactive Brokers uses dynamic risk management: they will simply sell your assets if they think the situation is too risky.  It's faster and harder to predict than a margin loan.

Yes this is correct. I rounded to 85% because I didn't want to write that 86.3637% drop would lead to a wipeout. But it's pretty much the same thing.


@waltworks what's wrong with small margin loan? Let say 5-10% kept over 10-20 years? Almost no risk of being wipeout

[waltworks]

The risk is, actively trading almost ensures you'll do worse than some random dead person whose relatives forgot about their 401k.

You can boost that to doing even worse with a margin loan or two!

-W

[MustacheAndaHalf]

10% margin:
80% drop triggers margin call
85% drop wipes out the portfolio

With 100k you borrow 10k, and have 110k invested.
An 85% drop means 110 x .15 = 16.5k
You pay off the 10k margin loan and have 6.5k left over.

I'm nit picking for an important reason: your math has to be correct when working with margin.  If you don't accurately predict what can happen in various scenarios, the leveraged losses can do a lot of damage.

For margin loans, Interactive Brokers uses dynamic risk management: they will simply sell your assets if they think the situation is too risky.  It's faster and harder to predict than a margin loan.

Yes this is correct. I rounded to 85% because I didn't want to write that 86.3637% drop would lead to a wipeout. But it's pretty much the same thing.

Both your original 85% and corrected 86.3637% are incorrect.  Did you agree with how I showed it was wrong?  If you agree, why not use the same approach to verify your numbers?

Subtract your number from 100%, multiply that by $110,000 and see if you have more than $10,000 left.  That will let you verify if you have the right number.
110 * (100 - 86.3637%) = 15

[helloyou]

10% margin:
80% drop triggers margin call
85% drop wipes out the portfolio

With 100k you borrow 10k, and have 110k invested.
An 85% drop means 110 x .15 = 16.5k
You pay off the 10k margin loan and have 6.5k left over.

I'm nit picking for an important reason: your math has to be correct when working with margin.  If you don't accurately predict what can happen in various scenarios, the leveraged losses can do a lot of damage.

For margin loans, Interactive Brokers uses dynamic risk management: they will simply sell your assets if they think the situation is too risky.  It's faster and harder to predict than a margin loan.

Yes this is correct. I rounded to 85% because I didn't want to write that 86.3637% drop would lead to a wipeout. But it's pretty much the same thing.

Both your original 85% and corrected 86.3637% are incorrect.  Did you agree with how I showed it was wrong?  If you agree, why not use the same approach to verify your numbers?

Subtract your number from 100%, multiply that by $110,000 and see if you have more than $10,000 left.  That will let you verify if you have the right number.
110 * (100 - 86.3637%) = 15

Actually you are correct. I've done the wrong calculation. The right number is 91% to wipeout the portfolio. I'm going to update the numbers :)

[deborah]

The Australian Stock Exchange looked at how well off people were with and without margin loans after 10 years. This period had no margin calls. The people who didn't borrow had increased their net worth almost exactly the same amount as the people who did. It's not worth the risk. Unfortunately, I'm not sure where the comparison study is located, as it was done a few years ago.

[marty998]

50% margin:
Meaning if I have 100k, I'd borrow 50k for a total of 150k to play with
If the portfolio drops by 33%, the reduced total would be 100k and any loss would start triggering margin call (ie. 50K is loan and 50K is my asset, so any further asset loss need to be covered)
If the portfolio drops by 66%. My account would be wiped out.

So, a 50% margin shouldn't be used most of the time as a 33% loss would already trigger margin call. Stop loss is mandatory to avoid tragedy. 

This is not how it works! 50k debt on a 150k portfolio means you have a 33% LVR, not 50%.

1) If the portfolio drops 33%, you will have 100k of assets, not 50k. Your new LVR is 50%, and your $100k of equity is now 50% (i.e. 50% loss when the market has fallen 33%).
2) Whether you get margin called or not depends on the kind of stocks you hold. Different margin loan providers have different LVRs on different stocks. Some will allow 75%, some will allow 40%. Some will have a list of stocks where the permitted LVR is 0%. These %'s can and do change in times of volatility.
3) If the portfolio drops 66%, yes you get wiped out because your LVR will be 100%. However, your margin loan provider will ask you to pay down the loan, or sell your stocks long before that happens - remember, the max gearing might be 75%. And that might be changed to 0% with very little notice. So you could be asked to sell as the market falls, and keep selling until the market bottoms out, at which point you have little capital left to ride the market back up.

Ask me how I know this.

Don't do it.

[MustacheAndaHalf]

Actually you are correct. I've done the wrong calculation. The right number is 91% to wipeout the portfolio. I'm going to update the numbers :)

Great - the math is extremely important, because it lets you plan ways to avoid a margin call or wipe out.

I've taken out a margin loan only once, back in April when Covid-19 cases declined for the first time ever.  The key thing isn't how well I did - that opportunity is gone either way.  It's the preparation and what I discovered before I was willing to go on margin.

I did all kinds of simulated market drops - even the great depression.  What happens if markets fell -25%, but then head towards -90% from here?  What happens if markets are going to drop a total of -50%?  I kept seeing wipe outs and disaster, which meant not going on margin.

My key insight is this: eat the loss.  Don't hope it goes away... when the stock market goes against you a little more than you predicted, start selling at a loss and paying off the margin loan.  I think by -25% or -30% I would have paid off the margin loan entirely, which means any loss below that is survivable.  So I would encourage you to look at what kind of loss you might see, and at what point you should eat that loss and pay down the margin loan.  Accepting the loss is a way to survive and invest another day.  Doing nothing - pretending everything will be okay - is how the loss grows bigger and bigger.

I don't expect to use a margin loan again, since I prefer leveraged ETFs (which have their own pitfalls, and typically don't beat regular ETFs over the long term).

[helloyou]

50% margin:
Meaning if I have 100k, I'd borrow 50k for a total of 150k to play with
If the portfolio drops by 33%, the reduced total would be 100k and any loss would start triggering margin call (ie. 50K is loan and 50K is my asset, so any further asset loss need to be covered)
If the portfolio drops by 66%. My account would be wiped out.

So, a 50% margin shouldn't be used most of the time as a 33% loss would already trigger margin call. Stop loss is mandatory to avoid tragedy. 

This is not how it works! 50k debt on a 150k portfolio means you have a 33% LVR, not 50%.

1) If the portfolio drops 33%, you will have 100k of assets, not 50k. Your new LVR is 50%, and your $100k of equity is now 50% (i.e. 50% loss when the market has fallen 33%).
2) Whether you get margin called or not depends on the kind of stocks you hold. Different margin loan providers have different LVRs on different stocks. Some will allow 75%, some will allow 40%. Some will have a list of stocks where the permitted LVR is 0%. These %'s can and do change in times of volatility.
3) If the portfolio drops 66%, yes you get wiped out because your LVR will be 100%. However, your margin loan provider will ask you to pay down the loan, or sell your stocks long before that happens - remember, the max gearing might be 75%. And that might be changed to 0% with very little notice. So you could be asked to sell as the market falls, and keep selling until the market bottoms out, at which point you have little capital left to ride the market back up.

Ask me how I know this.

Don't do it.

Yes agree on all your point. I think we said the same thing. On point 1 you get 50% loss when it drop by 33% and margin calls are trigger to cover loss (i know there would be variability depending on stock but this is calculatiom for simplicity)

So yeah I'd be keen to hear your story about how you know this? Tragic story of margin call?

[helloyou]

Actually you are correct. I've done the wrong calculation. The right number is 91% to wipeout the portfolio. I'm going to update the numbers :)

Great - the math is extremely important, because it lets you plan ways to avoid a margin call or wipe out.

I've taken out a margin loan only once, back in April when Covid-19 cases declined for the first time ever.  The key thing isn't how well I did - that opportunity is gone either way.  It's the preparation and what I discovered before I was willing to go on margin.

I did all kinds of simulated market drops - even the great depression.  What happens if markets fell -25%, but then head towards -90% from here?  What happens if markets are going to drop a total of -50%?  I kept seeing wipe outs and disaster, which meant not going on margin.

My key insight is this: eat the loss.  Don't hope it goes away... when the stock market goes against you a little more than you predicted, start selling at a loss and paying off the margin loan.  I think by -25% or -30% I would have paid off the margin loan entirely, which means any loss below that is survivable.  So I would encourage you to look at what kind of loss you might see, and at what point you should eat that loss and pay down the margin loan.  Accepting the loss is a way to survive and invest another day.  Doing nothing - pretending everything will be okay - is how the loss grows bigger and bigger.

I don't expect to use a margin loan again, since I prefer leveraged ETFs (which have their own pitfalls, and typically don't beat regular ETFs over the long term).

I actually think that leverage ETF are more dangerous than margin loan. I don't get why people think they are safer because they can only go to 0.

During the march crash I've actually seen 1 person having her portfolio halved permanently because some of her leveraged ETF went to 0  with no hope of recovery. When you double or triple the gain, you also do the same thing with losses.

These leveraged ETF are also derivative that are expensive long term. They are not made to be hold long term and are only supposed to be kept on a daily basis. If you check the long term trend of any of these 2x or 3x etf, you'll see that over 10 years time MOST of them are loosing money.


However, with margin loan, if I am on an affordable 10-20% margin, a 30% market drop won't kill permanently some of my assets and it'll recover the same way as the market does.


My plan is really much to have a margin loan low enough so that I can hold them and ride a downturn. I can't see how a 10% margin would wipe my portfolio out. It would need a 90%+ market drop but by then it would be the end of finance

[MustacheAndaHalf]

The pitfalls of leveraged ETFs are numerous, I agree.  I'll give two examples.

Some leveraged oil ETFs plunged lower and lower, and people waited for the recovery.  But it got so bad some leveraged oil ETFs became insolvent, and simply closed down, returning whatever money was left... after falling all the way down.  So you could take a -95% loss on the way down... and then get your money back.  With nothing to invest in to make the profit back.

Another example is an oil/gas exploration ETF.  It lost 99.8% of it's value or so, and derivatives became more expensive.  In order to cope with the increased costs, the ETF went from +300% leverage to +200% leverage.  Meaning, you lost -99.8% on the way down at 3X leverage, and had no chance at a full recovery since the ETF dropped to 2X leverage.

And then there's volatility drag, .... but I said only two examples.  Now if you have $25,000 at Interactive Brokers, and take out a $50,000 loan, you pay 1.55% on the loan.  That's like paying 3.1% on $25,000.  If you put your $25,000 into a 3X leveraged ETF (which you shouldn't), you're paying about 1% on $25,000.  Leveraged ETFs do seem to offer cheaper loans for the same exposure, but there's other trade offs.

[celerystalks]

Are the interest rates paid and margin collateral requirements subject to change without notice?

[Telecaster]

Read the fine print on your margin agreement very, very carefully.   It will lay out their policy of when they invoke a margin call.   It probably goes onto say they don't have to follow their policy.  That is, they can call it whenever they want.  Your broker might not have that language, but they usually do.   

[helloyou]

The pitfalls of leveraged ETFs are numerous, I agree.  I'll give two examples.

Some leveraged oil ETFs plunged lower and lower, and people waited for the recovery.  But it got so bad some leveraged oil ETFs became insolvent, and simply closed down, returning whatever money was left... after falling all the way down.  So you could take a -95% loss on the way down... and then get your money back.  With nothing to invest in to make the profit back.

Another example is an oil/gas exploration ETF.  It lost 99.8% of it's value or so, and derivatives became more expensive.  In order to cope with the increased costs, the ETF went from +300% leverage to +200% leverage.  Meaning, you lost -99.8% on the way down at 3X leverage, and had no chance at a full recovery since the ETF dropped to 2X leverage.

And then there's volatility drag, .... but I said only two examples.  Now if you have $25,000 at Interactive Brokers, and take out a $50,000 loan, you pay 1.55% on the loan.  That's like paying 3.1% on $25,000.  If you put your $25,000 into a 3X leveraged ETF (which you shouldn't), you're paying about 1% on $25,000.  Leveraged ETFs do seem to offer cheaper loans for the same exposure, but there's other trade offs.

Yea different trade off but my point is that they are riskier on both long term (you won't make as much money on a 3x SPY over 10 years than a non leversged one) AND have more risk of being wipe out as well.

A "safer" 2X etf when the market drop 50% would worth 0. Then its over.

With a smaller 20% margin, the market can drop 50%, and I still wouldn't have a margin call and can ride it through AND I can keep it 10 years if I wanted to

[ChpBstrd]

IDK if we can have a conversation about using margin safely without getting into the topic of what you’re going to buy with the loan.

BND?
LQD?
TSLA short calls?


Tagging @Financial.Velociraptor

[marty998]

50% margin:
Meaning if I have 100k, I'd borrow 50k for a total of 150k to play with
If the portfolio drops by 33%, the reduced total would be 100k and any loss would start triggering margin call (ie. 50K is loan and 50K is my asset, so any further asset loss need to be covered)
If the portfolio drops by 66%. My account would be wiped out.

So, a 50% margin shouldn't be used most of the time as a 33% loss would already trigger margin call. Stop loss is mandatory to avoid tragedy. 

This is not how it works! 50k debt on a 150k portfolio means you have a 33% LVR, not 50%.

1) If the portfolio drops 33%, you will have 100k of assets, not 50k. Your new LVR is 50%, and your $100k of equity is now 50% (i.e. 50% loss when the market has fallen 33%).
2) Whether you get margin called or not depends on the kind of stocks you hold. Different margin loan providers have different LVRs on different stocks. Some will allow 75%, some will allow 40%. Some will have a list of stocks where the permitted LVR is 0%. These %'s can and do change in times of volatility.
3) If the portfolio drops 66%, yes you get wiped out because your LVR will be 100%. However, your margin loan provider will ask you to pay down the loan, or sell your stocks long before that happens - remember, the max gearing might be 75%. And that might be changed to 0% with very little notice. So you could be asked to sell as the market falls, and keep selling until the market bottoms out, at which point you have little capital left to ride the market back up.

Ask me how I know this.

Don't do it.

Yes agree on all your point. I think we said the same thing. On point 1 you get 50% loss when it drop by 33% and margin calls are trigger to cover loss (i know there would be variability depending on stock but this is calculatiom for simplicity)

So yeah I'd be keen to hear your story about how you know this? Tragic story of margin call?

Yes. 2008. I had investments in basically the top 10 stocks on our market. What could go wrong eh? Was 50% geared and kept having to sell (sold early before getting margin called). Still lost 75% of my portfolio.

Didn’t have much capital left to ride it back up but lost a little more in the 2012 bear market here.

It’s taken until this year to eliminate all my tax losses from that time LOL.

Margin loans suck in young and dumb hands. I still have the facility open, but when I buy I immediately clear the loan. It’s flexible that I can buy at opportune times, if I need a few days to organise the actual cash to buy the shares.

[MustacheAndaHalf]

@helloyou - Your original post says you bought "stocks" on margin.  Does that mean shares in individual companies?

When I bought on margin for 1 week, I bought broad market ETFs.  I planned to sell off if markets began dropping.  But ideally, I'd have a computer program or system of rules that automatically paid off my margin loan.  As seen in March, markets can drop -7% before there's much time to react.

(Forgot to add another example of leveraged ETFs going wrong: 12 month returns of two ETFs.
SPY: +6.6% ... 3X leveraged version UPRO: -19.6%
The daily 3X price moves follow a path that might not resemble their annual performance)

[Financial.Velociraptor]

IDK if we can have a conversation about using margin safely without getting into the topic of what you’re going to buy with the loan.

BND?
LQD?
TSLA short calls?


Tagging @Financial.Velociraptor

Some margin is safer than others.  For example, a net debit (options spread) has defined risk equal to the debit.  A naked call has theoretically unlimited losses.  I could see a long term strategy of buying a ton of PDI and levering up 25%.   You'd make about 16.5% annualized, minus interest.  Put the rest in long puts to hedge your risk.  Could outperform most markets with great current income for retirees. 

[helloyou]

50% margin:
Meaning if I have 100k, I'd borrow 50k for a total of 150k to play with
If the portfolio drops by 33%, the reduced total would be 100k and any loss would start triggering margin call (ie. 50K is loan and 50K is my asset, so any further asset loss need to be covered)
If the portfolio drops by 66%. My account would be wiped out.

So, a 50% margin shouldn't be used most of the time as a 33% loss would already trigger margin call. Stop loss is mandatory to avoid tragedy. 

This is not how it works! 50k debt on a 150k portfolio means you have a 33% LVR, not 50%.

1) If the portfolio drops 33%, you will have 100k of assets, not 50k. Your new LVR is 50%, and your $100k of equity is now 50% (i.e. 50% loss when the market has fallen 33%).
2) Whether you get margin called or not depends on the kind of stocks you hold. Different margin loan providers have different LVRs on different stocks. Some will allow 75%, some will allow 40%. Some will have a list of stocks where the permitted LVR is 0%. These %'s can and do change in times of volatility.
3) If the portfolio drops 66%, yes you get wiped out because your LVR will be 100%. However, your margin loan provider will ask you to pay down the loan, or sell your stocks long before that happens - remember, the max gearing might be 75%. And that might be changed to 0% with very little notice. So you could be asked to sell as the market falls, and keep selling until the market bottoms out, at which point you have little capital left to ride the market back up.

Ask me how I know this.

Don't do it.

Yes agree on all your point. I think we said the same thing. On point 1 you get 50% loss when it drop by 33% and margin calls are trigger to cover loss (i know there would be variability depending on stock but this is calculatiom for simplicity)

So yeah I'd be keen to hear your story about how you know this? Tragic story of margin call?

Yes. 2008. I had investments in basically the top 10 stocks on our market. What could go wrong eh? Was 50% geared and kept having to sell (sold early before getting margin called). Still lost 75% of my portfolio.

Didn’t have much capital left to ride it back up but lost a little more in the 2012 bear market here.

It’s taken until this year to eliminate all my tax losses from that time LOL.

Margin loans suck in young and dumb hands. I still have the facility open, but when I buy I immediately clear the loan. It’s flexible that I can buy at opportune times, if I need a few days to organise the actual cash to buy the shares.

Damn I'm sorry for it.

Do you think this could have been avoided if you've put stop losses? Or at least limit losses?

[helloyou]

@helloyou - Your original post says you bought "stocks" on margin.  Does that mean shares in individual companies?

When I bought on margin for 1 week, I bought broad market ETFs.  I planned to sell off if markets began dropping.  But ideally, I'd have a computer program or system of rules that automatically paid off my margin loan.  As seen in March, markets can drop -7% before there's much time to react.

(Forgot to add another example of leveraged ETFs going wrong: 12 month returns of two ETFs.
SPY: +6.6% ... 3X leveraged version UPRO: -19.6%
The daily 3X price moves follow a path that might not resemble their annual performance)

I've bought some individual and etf stock on margin. The total is about 10% and I intend to sell-off some to have a stronger cash position. I made some mistake where I forgot to put stop loss and now it went down so I'd like some recovery before selling

[Telecaster]

Damn I'm sorry for it.

Do you think this could have been avoided if you've put stop losses? Or at least limit losses?

Just because you have stops in place, it doesn't mean your orders will get filled at the stop price.  In fact, if the market is plunging it is virtually guaranteed your orders won't be filled at the stop price.   Similarly, in a plunging market your limit order might not get filled at all.   So no, stop and limit orders are false security. 

[helloyou]

Damn I'm sorry for it.

Do you think this could have been avoided if you've put stop losses? Or at least limit losses?

Just because you have stops in place, it doesn't mean your orders will get filled at the stop price.  In fact, if the market is plunging it is virtually guaranteed your orders won't be filled at the stop price.   Similarly, in a plunging market your limit order might not get filled at all.   So no, stop and limit orders are false security.

Yeah but you can still use stop limit which sell at the next lowest point. And use alerts as well

[The_Big_H]

So almost every one - HERE - is OK with this???

I feel like I'm taking crazy pills.

[MustacheAndaHalf]

@helloyou - Your original post says you bought "stocks" on margin.  Does that mean shares in individual companies?

When I bought on margin for 1 week, I bought broad market ETFs.  I planned to sell off if markets began dropping.  But ideally, I'd have a computer program or system of rules that automatically paid off my margin loan.  As seen in March, markets can drop -7% before there's much time to react.

(Forgot to add another example of leveraged ETFs going wrong: 12 month returns of two ETFs.
SPY: +6.6% ... 3X leveraged version UPRO: -19.6%
The daily 3X price moves follow a path that might not resemble their annual performance)

I've bought some individual and etf stock on margin. The total is about 10% and I intend to sell-off some to have a stronger cash position. I made some mistake where I forgot to put stop loss and now it went down so I'd like some recovery before selling

My point is the exact opposite of what you're doing.  How do you think people get wiped out on leverage?

First they have a loss, and they wait for "some recovery"... but the markets don't care, and the leveraged loss happens again.  Now their only hope of recovery is to stay leveraged... sometimes it will work, giving false hope for those times when it won't.  That's how people get wiped out: they don't accept the loss and pay off the margin loan.  They wait for recovery which doesn't arrive.

I guess you need to learn from experience.  I'll say don't use margin, or at least don't go past 10% margin.  But I think that's not how this story ends.

[MustacheAndaHalf]

So almost every one - HERE - is OK with this???

I feel like I'm taking crazy pills.

I see lots of people giving reasons to be cautious, or pointing out problems.  I don't agree with your assessment that "almost every one" is approving of it.

[helloyou]

@helloyou - Your original post says you bought "stocks" on margin.  Does that mean shares in individual companies?

When I bought on margin for 1 week, I bought broad market ETFs.  I planned to sell off if markets began dropping.  But ideally, I'd have a computer program or system of rules that automatically paid off my margin loan.  As seen in March, markets can drop -7% before there's much time to react.

(Forgot to add another example of leveraged ETFs going wrong: 12 month returns of two ETFs.
SPY: +6.6% ... 3X leveraged version UPRO: -19.6%
The daily 3X price moves follow a path that might not resemble their annual performance)

I've bought some individual and etf stock on margin. The total is about 10% and I intend to sell-off some to have a stronger cash position. I made some mistake where I forgot to put stop loss and now it went down so I'd like some recovery before selling

My point is the exact opposite of what you're doing.  How do you think people get wiped out on leverage?

First they have a loss, and they wait for "some recovery"... but the markets don't care, and the leveraged loss happens again.  Now their only hope of recovery is to stay leveraged... sometimes it will work, giving false hope for those times when it won't.  That's how people get wiped out: they don't accept the loss and pay off the margin loan.  They wait for recovery which doesn't arrive.

I guess you need to learn from experience.  I'll say don't use margin, or at least don't go past 10% margin.  But I think that's not how this story ends.

10% is the maximum margin I could take without stop loss. Ideally it would be at 5% so that it will be virtually impossible to be wiped out.

Any higher margin, which I may do, would have stop loss as soon as it drops below some % points. I'm investing mainly on conservative stock like the SPY or brk.b so I don't expect liquidity problems and should be able to easily sell if it needs to be.

[maizefolk]

@helloyou - Your original post says you bought "stocks" on margin.  Does that mean shares in individual companies?

When I bought on margin for 1 week, I bought broad market ETFs.  I planned to sell off if markets began dropping.  But ideally, I'd have a computer program or system of rules that automatically paid off my margin loan.  As seen in March, markets can drop -7% before there's much time to react.

(Forgot to add another example of leveraged ETFs going wrong: 12 month returns of two ETFs.
SPY: +6.6% ... 3X leveraged version UPRO: -19.6%
The daily 3X price moves follow a path that might not resemble their annual performance)

I've bought some individual and etf stock on margin. The total is about 10% and I intend to sell-off some to have a stronger cash position. I made some mistake where I forgot to put stop loss and now it went down so I'd like some recovery before selling

My point is the exact opposite of what you're doing.  How do you think people get wiped out on leverage?

First they have a loss, and they wait for "some recovery"... but the markets don't care, and the leveraged loss happens again.  Now their only hope of recovery is to stay leveraged... sometimes it will work, giving false hope for those times when it won't.  That's how people get wiped out: they don't accept the loss and pay off the margin loan.  They wait for recovery which doesn't arrive.

I guess you need to learn from experience.  I'll say don't use margin, or at least don't go past 10% margin.  But I think that's not how this story ends.

helloyou, the Bogleheads thread by "market timer" is always an excellent read. His specific fatal flaw was exactly that of waiting for a recovery once stock prices started going down. Instead of cutting his losses, he kept feeding more money into the market to try to avoid being liquidated in margin calls right through the year that was 2008.

I recommend starting here: https://www.bogleheads.org/forum/viewtopic.php?f=10&t=5934&start=203

While it is a long thread, you can shorten it a lot by reading only market timer's posts and not all the responses from other forum members.

Personally, it convinced me that leverage was not for me. Even if I start out small, the temptation to wait for a recovery before selling and get myself in much deeper seems to risky to me personally.

[helloyou]

@helloyou - Your original post says you bought "stocks" on margin.  Does that mean shares in individual companies?

When I bought on margin for 1 week, I bought broad market ETFs.  I planned to sell off if markets began dropping.  But ideally, I'd have a computer program or system of rules that automatically paid off my margin loan.  As seen in March, markets can drop -7% before there's much time to react.

(Forgot to add another example of leveraged ETFs going wrong: 12 month returns of two ETFs.
SPY: +6.6% ... 3X leveraged version UPRO: -19.6%
The daily 3X price moves follow a path that might not resemble their annual performance)

I've bought some individual and etf stock on margin. The total is about 10% and I intend to sell-off some to have a stronger cash position. I made some mistake where I forgot to put stop loss and now it went down so I'd like some recovery before selling

My point is the exact opposite of what you're doing.  How do you think people get wiped out on leverage?

First they have a loss, and they wait for "some recovery"... but the markets don't care, and the leveraged loss happens again.  Now their only hope of recovery is to stay leveraged... sometimes it will work, giving false hope for those times when it won't.  That's how people get wiped out: they don't accept the loss and pay off the margin loan.  They wait for recovery which doesn't arrive.

I guess you need to learn from experience.  I'll say don't use margin, or at least don't go past 10% margin.  But I think that's not how this story ends.

helloyou, the Bogleheads thread by "market timer" is always an excellent read. His specific fatal flaw was exactly that of waiting for a recovery once stock prices started going down. Instead of cutting his losses, he kept feeding more money into the market to try to avoid being liquidated in margin calls right through the year that was 2008.

I recommend starting here: https://www.bogleheads.org/forum/viewtopic.php?f=10&t=5934&start=203

While it is a long thread, you can shorten it a lot by reading only market timer's posts and not all the responses from other forum members.

Personally, it convinced me that leverage was not for me. Even if I start out small, the temptation to wait for a recovery before selling and get myself in much deeper seems to risky to me personally.

Thanks very interesting I've had a scan and I'll go deeper into it.

What I've seen so far is that the guy started from a 2X leverage SPY to a 6X on borrowed money.

So he isn't being killed by using margin but instead being killed by leverage funds. These are exactly what I said were more dangerous than using margin because they multiply his losses

I can't see how a 10-20% margin is comparable to someone using a 2-6X leveraged fund, which would be equivalent to margin my account by 200-600% which would put risk way above the roof

[marty998]

Damn I'm sorry for it.

Do you think this could have been avoided if you've put stop losses? Or at least limit losses?

Just because you have stops in place, it doesn't mean your orders will get filled at the stop price.  In fact, if the market is plunging it is virtually guaranteed your orders won't be filled at the stop price.   Similarly, in a plunging market your limit order might not get filled at all.   So no, stop and limit orders are false security.

Yeah but you can still use stop limit which sell at the next lowest point. And use alerts as well

Stop losses and things weren't really a big thing over here back then. And why would I have implemented it anyway? I faithfully followed the mantra of long term investing, don't panic sell, markets always recover etc etc.

I was an idiot obviously.

No one expected our sharemarket to fall 55%. It was the US that was completely fucked. The Australian housing market basically boomed over 2007-2011.

The contagion from rubbish overseas institutions nearly brought ours down, but otherwise we had an economy powered by proper government stimulus and a huge windfall from mining exports.

There wasn't really a reason to sell if you were a long term investor....

[helloyou]

Damn I'm sorry for it.

Do you think this could have been avoided if you've put stop losses? Or at least limit losses?

Just because you have stops in place, it doesn't mean your orders will get filled at the stop price.  In fact, if the market is plunging it is virtually guaranteed your orders won't be filled at the stop price.   Similarly, in a plunging market your limit order might not get filled at all.   So no, stop and limit orders are false security.

Yeah but you can still use stop limit which sell at the next lowest point. And use alerts as well

Stop losses and things weren't really a big thing over here back then. And why would I have implemented it anyway? I faithfully followed the mantra of long term investing, don't panic sell, markets always recover etc etc.

I was an idiot obviously.

No one expected our sharemarket to fall 55%. It was the US that was completely fucked. The Australian housing market basically boomed over 2007-2011.

The contagion from rubbish overseas institutions nearly brought ours down, but otherwise we had an economy powered by proper government stimulus and a huge windfall from mining exports.

There wasn't really a reason to sell if you were a long term investor....

I'd say anyone using over 20% margin should have stop loss and start selling as soon as it goes down to the maximum loss/risk one could take.

With a 50% gearing / margin, its asking for trouble not having protection against downturn. Even without stop loss you could have got some uncorrelated or inverse etf to be protected.

On my side, when I increase margin, I have stop loss when it drop only by few % points.

Of course, if you have a small 5% margin then you can ride it long term...

[Much Fishing to Do]

Trying to look at this from an extremely low risk viewpoint within my portfolio.  If I did 5% margin to basically add to my VASGX (significant part of my portfolio) seems like almost no chance of a call and I suspect I'll make more than 1.5% over say 20 years almost for sure.  So I guess my question would be how long does that money stay 1.5%? (seems like these rates could change naturally or these low rates are teasers by those certain brokers to get people in and fully intend to raise it at some point) I assume it moves and could move quickly enough that it could be at say 6% in a shorter period of time than I would want to stay invested to be virtually assured I'll be up instead of down on what I purchase with it today?

After watching 2000 & 2008 I can't even imagine being over 10% leveraged.

[helloyou]

Trying to look at this from an extremely low risk viewpoint within my portfolio.  If I did 5% margin to basically add to my VASGX (significant part of my portfolio) seems like almost no chance of a call and I suspect I'll make more than 1.5% over say 20 years almost for sure.  So I guess my question would be how long does that money stay 1.5%? (seems like these rates could change naturally or these low rates are teasers by those certain brokers to get people in and fully intend to raise it at some point) I assume it moves and could move quickly enough that it could be at say 6% in a shorter period of time than I would want to stay invested to be virtually assured I'll be up instead of down on what I purchase with it today?

After watching 2000 & 2008 I can't even imagine being over 10% leveraged.

Interest rate is defined by central banks. So as long as it remains close to 0, then borrowing will remain super cheap. I don't expect any significant increase in interest for the next 3 years. Then if central bank decide to increase interest rate it would be gradual. So I'm not really worried about that. Although when interest rate start creeping above 3% I'll stop using margin loan for long term hold

[ChpBstrd]

So almost every one - HERE - is OK with this???

I feel like I'm taking crazy pills.

When you’ve been talking stocks on the internet as long as I have, you realize that everyone’s caution gets reduced when the market rises quickly. The tone on this forum is now a lot more supportive than it was just 3 months ago, when the words “idiot” and “depression” were being dished out like runny mashed potatoes and gravy in a school lunch line. The snarky condescension is now limited to the bearish threads. This will all roll over if and when the market does, because internet opinions are trailing indicators.

[Much Fishing to Do]

Trying to look at this from an extremely low risk viewpoint within my portfolio.  If I did 5% margin to basically add to my VASGX (significant part of my portfolio) seems like almost no chance of a call and I suspect I'll make more than 1.5% over say 20 years almost for sure.  So I guess my question would be how long does that money stay 1.5%? (seems like these rates could change naturally or these low rates are teasers by those certain brokers to get people in and fully intend to raise it at some point) I assume it moves and could move quickly enough that it could be at say 6% in a shorter period of time than I would want to stay invested to be virtually assured I'll be up instead of down on what I purchase with it today?

After watching 2000 & 2008 I can't even imagine being over 10% leveraged.

Interest rate is defined by central banks. So as long as it remains close to 0, then borrowing will remain super cheap. I don't expect any significant increase in interest for the next 3 years. Then if central bank decide to increase interest rate it would be gradual. So I'm not really worried about that. Although when interest rate start creeping above 3% I'll stop using margin loan for long term hold

OK, maybe I'm just being suckered by commercials (wouldnt be the first time) but I thought the 1.5% was the very rare brokerage deal and its more like 5%+ at most places at most times

[maizefolk]

Interactive Brokers offers margin rates well below most other brokerages (and seems to have done so consistently for years).

That said, I'd be curious to see if, over the long term, margin loan interest rates are better correlated with the interest rates set by the fed, or with consumer inflation.

[helloyou]

Trying to look at this from an extremely low risk viewpoint within my portfolio.  If I did 5% margin to basically add to my VASGX (significant part of my portfolio) seems like almost no chance of a call and I suspect I'll make more than 1.5% over say 20 years almost for sure.  So I guess my question would be how long does that money stay 1.5%? (seems like these rates could change naturally or these low rates are teasers by those certain brokers to get people in and fully intend to raise it at some point) I assume it moves and could move quickly enough that it could be at say 6% in a shorter period of time than I would want to stay invested to be virtually assured I'll be up instead of down on what I purchase with it today?

After watching 2000 & 2008 I can't even imagine being over 10% leveraged.

Interest rate is defined by central banks. So as long as it remains close to 0, then borrowing will remain super cheap. I don't expect any significant increase in interest for the next 3 years. Then if central bank decide to increase interest rate it would be gradual. So I'm not really worried about that. Although when interest rate start creeping above 3% I'll stop using margin loan for long term hold

OK, maybe I'm just being suckered by commercials (wouldnt be the first time) but I thought the 1.5% was the very rare brokerage deal and its more like 5%+ at most places at most times

They have the lowest rate on the market. And its only because the rate is so low that I say I can ride it long term.

If the interest was 4% I would never want to keep it longer than few weeks/months. And would never have suggested this long term margin strategy

[Goldielocks]

You're gonna shoot your eye out, kid.

-W

If you are buying on margin, why not buy some options to hedge your risk at the same time, to put a bottom limit on your out of pocket exposure?

[waltworks]

You're gonna shoot your eye out, kid.

-W

If you are buying on margin, why not buy some options to hedge your risk at the same time, to put a bottom limit on your out of pocket exposure?

To clarify, I thought the OP should not use leverage at all.

I like to not have my investments be a job, but I'm sure there's a complex strategy to hedge against the downsides of your margin loan. Blech.

-W

[Goldielocks]

I liked and agreed with your comment, so I replied to it, but my message was for OP.  Oops.

OP may have more interest in spending the time figuring out the cost of margin + purchasing hedged options versus investments, that either you or I do.

I had some margin trades a long time ago, when my total invested assets were around $100k.   After a while, (ok after a margin call that I was ok for, but it opened my eyes), I realized that if I wanted to leverage, a HELOC would be a better plan, as I could delay / plan more when to free up the investments versus a margin call.   I just needed to watch out for the rates.

Within a few years of doing that, I realized that just focusing on trimming expenses to invest more cash (and / or starting my own side business including at one time real estate rentals) made the most sense of all.  A much better place to put my focus of effort and time than scouring for arbitrage, margin rate, HELOC rates, options and such.

[vand]

The leverage amount is not how you should think about it.

The correct way to think about it and the way to instill discipline in your trading is to determine your exit position first, and how much of your trading account you are willing to lose on any one single trade.  I would suggest no more than 5%.

Then size your trade so that if when you hit your stop loss the dollar loss amount is equal the amount you were willing to risk.

So, if you have a trading account of $1000,  and your entry price on a position is 200 and you determine that you will get out of the trade if the price falls 17 points below to 183, then you should bet $2.94 per point to give yourself the equivilent of $588 of market exposure on a position, such that if it falls to your stop loss point it means you lose (17*2.94) $50, ie 5% .

[Much Fishing to Do]

They have the lowest rate on the market. And its only because the rate is so low that I say I can ride it long term.

If the interest was 4% I would never want to keep it longer than few weeks/months. And would never have suggested this long term margin strategy

But that's my point, right?  If they are the only ones with this kind of rate it could be just a tool to bring in accounts and in say one year they could move it to 4%, because they can because that's still a competitive rate.  Its not like at the point they raise it you can necessarily sell b/c then its not the long term investment as planned (so could be down, etc).

Or am I getting this wrong? (is the rate fixed for as long as you want it? or am I missing something else?)  I do like the idea but am trying to find the potential downsides and this just seems to be one.

[ChpBstrd]

They have the lowest rate on the market. And its only because the rate is so low that I say I can ride it long term.

If the interest was 4% I would never want to keep it longer than few weeks/months. And would never have suggested this long term margin strategy

But that's my point, right?  If they are the only ones with this kind of rate it could be just a tool to bring in accounts and in say one year they could move it to 4%, because they can because that's still a competitive rate.  Its not like at the point they raise it you can necessarily sell b/c then its not the long term investment as planned (so could be down, etc).

Or am I getting this wrong? (is the rate fixed for as long as you want it? or am I missing something else?)  I do like the idea but am trying to find the potential downsides and this just seems to be one.

I’ve been watching IB for a few years and they have consistently had the lowest margin costs available. How they can do this is another question. It would seem a money losing proposition to borrow at their corporate rate and lend near the US treasury rate.

Overall I agree they are using cheap margin, and in years past extra-low commissions, to attract accounts. Best of all, it attracts active trader accounts more so than buy-and-holders. The cost of providing cheap margin offset the need for other costs, like advertising.

[helloyou]

Their rate is from 0.3% to 1.5% (depending on your account size) on top of the central bank rate.
https://www.interactivebrokers.com/en/index.php?f=46376&p=m

So with current FED interest rate at 0, you pay just 1% for the margin loan which is still 1% money for them. Margin call and management are all automated. There are no need to go into recovery and no need to warn people if they get close to it.

If you look at their latest earning report (https://investors.interactivebrokers.com/en/index.php?f=1559&p=releases#), their customers margin loans amount to $19.8 billion. So with everything automated, the scale of loans they generate is enough to make good money I believe.

[MustacheAndaHalf]

Most brokerages like to give a fake margin loan interest, then add a number to it.  It's consistent enough across brokerages that it's probably legally required language.  Here's the rates for a margin loan of $50,000:

https://investor.vanguard.com/investing/margin
Vanguard adds a +6.0% "base rate", so they show both "1.50%" and "7.50%" in that table.

https://www.schwab.com/margin/rates
Schwab does the same with a +6.5% base rate, showing both "0.375%" and "6.875%"

https://www.fidelity.com/trading/margin-loans/margin-rates
Fidelity mentions that "6.875%" is "(0.200% below base rate)" of 7.075%.

https://www.interactivebrokers.com/en/index.php?f=46376
Interactive Brokers mentions a Benchmark Rate each time, with "1.59%" being "+1.5%" over benchmark.


It's also worth mentioning that margin rates can change with interest rates, which might be part of why each brokerage splits their rates between interest rate and base rate.  According to Fed chairman Powell, the Fed doesn't expect to raise rates in 2021.

[Financial.Velociraptor]

I watch the margin rate at IB because it is my "emergency fund".  That is, I stay fully invested and if the A/C compressor goes out, I borrow from IB at the going rate until I can pay it back.  I've seen the rate go as high as 2.15%.  It is a variable rate but always a trivial premium to the Fed Funds rate.

[vand]

Personally I believe the title of this thread is something of a oxymoron.

Financial leverage is never safe, not because of the maths, but because of the psychology. What gets people into trouble is always that they increase their position in trades going against them rather than cutting their losses.

When you buy an index with no leverage you can and should buy more of it the further it falls, but when you introduce even the tiniest amount of leverage then that rule should be flipped; you should only pyramid up on a position that is in profit and never add to a losing position.

We don’t discuss trading much on this forum but if you want a primer then get Market Wizards, or Reminisces Of A Stock Operator, or both.

[hodedofome]

If you’re gonna be leveraged you need to have stop losses in place to control the downside.

Put this strategy on some leverage and you’ll have greater than market returns with much less volatility.

https://www.portfoliovisualizer.com/test-market-timing-model?s=y&coreSatellite=false&timingModel=5&startYear=1985&endYear=2020&includeYTD=false&initialAmount=10000&periodicAdjustment=0&adjustmentAmount=0&inflationAdjusted=true&adjustmentPercentage=0.0&adjustmentFrequency=4&symbol=SPY+IEF&singleAbsoluteMomentum=false&volatilityTarget=9.0&downsideVolatility=false&outOfMarketStartMonth=5&outOfMarketEndMonth=10&outOfMarketAssetType=1&movingAverageSignal=1&movingAverageType=1&multipleTimingPeriods=false&periodWeighting=2&windowSize=10&windowSizeInDays=105&movingAverageType2=1&windowSize2=10&windowSizeInDays2=105&excludePreviousMonth=false&normalizeReturns=false&volatilityWindowSize=0&volatilityWindowSizeInDays=0&assetsToHold=1&allocationWeights=1&riskControl=false&riskWindowSize=10&riskWindowSizeInDays=0&rebalancePeriod=1&separateSignalAsset=false&tradeExecution=0&comparedAllocation=0&timingPeriods%5B0%5D=5&timingUnits%5B0%5D=2&timingWeights%5B0%5D=100&timingUnits%5B1%5D=2&timingWeights%5B1%5D=0&timingUnits%5B2%5D=2&timingWeights%5B2%5D=0&timingUnits%5B3%5D=2&timingWeights%5B3%5D=0&timingUnits%5B4%5D=2&timingWeights%5B4%5D=0&volatilityPeriodUnit=1&volatilityPeriodWeight=0&symbol1=SPY&allocation1_1=50&symbol2=IEF&allocation2_1=50

[ChpBstrd]

When you buy an index with no leverage you can and should buy more of it the further it falls, but when you introduce even the tiniest amount of leverage then that rule should be flipped; you should only pyramid up on a position that is in profit and never add to a losing position.

I'm intrigued by this alteration of the dominant strategy due to leverage. I suppose that is because the risk/reward line is so much steeper when leverage is used that the risk of a "game over" insolvency event is so much closer. Additionally, because the upside is so steep, you are trying different trades to find one that will go up and up until you are rich (e.g. bullish on TSLA 3 months ago). And the only way to do that is to quickly cull the losing attempts before they become "game over" events. Is there anything I'm missing with regard to this gambling strategy?