Lessons in Margin trading By Dr. Bobby Srinivasan and Dr. Sudhakar Balachandran

September 3, 2015 | Posted by bobbysrinivasan << back to blog

The global stock markets took a pounding yesterday. As the decline started all the support levels gave way to a free fall in stock prices which reached to ridiculous levels. Trying to explain this phenomenon which happens every couple of years is purely futile since the emotion of aggregate fear becomes visible to all those who watch the market price movement avidly. One starts wondering as to why this happens. You say to yourself, “upto yesterday, everything looked nice and dandy why this is happening” today. The immediate explanation that will be given to you which will read like this, “This is due to contagion effect. Shanghai market fell 9% on Monday (24/08/2015). The Indian Sensex fell 1625 points”. Look at facts the fall in Shanghai market is due to healthy correction. The market literally doubled in the last two years. Too much speculation and hence the drop stands justified. But is it true for the Indian market? Our market has been stagnating from the beginning of the year and so the overheating argument does not hold good. So what really triggered the collapse which wiped out nearly 7 lakh crore rupees from the market capitalization? The answer could be found in the following possibilities.

The FII own 45% of all our tradable stocks before the crash. The value of their holdings was in excess of 1.9 lakh crore rupees. So seeing the Shanghai market collapse, they rushed to sell and this created the pandemonium that followed. Since no body knows the true value of these stocks, panic ensued and this battered the market. When the FIIs exited the poor and uninformed retail investors panicked and made an effort to exit the market at all costs. Generally these are the bunch of people, so poorly informed about other participants and their attitudes. They rush to jump out of the burning train to save at least part of their investment.
Margin trading a much desired tool to enhance wealth rapidly when the market is moving up and the most damaging one when the market is on the decline. The brokerage firms which have extended the margin to traders send out margin call (asking the traders to put in additional funds because of the decreased stock value).

When this call is not honoured, the brokerage houses start unloading the clients share as rapidly as they can to protect themselves. The poor investor who took the margin arrangement will get slaughtered by the market price movements. For example, the size of margin in the US market has increased six fold in the last fifteen years and it is not surprising that the US Dow Jones opened with a gap down of 1100 points.

Finally all these suggest that if you are a retail trader in the Indian market, you will be decimated when these big price movements take place. The problem is further exacerbated because of the algotrading which has all the potential to kill the retail trader. For all those retail investor, remember the song, “Fools rush in when angels fear to tread”.

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