Margin, not a good idea

I got a margin call again last week. I thought I had solved the problem after the first margin call, because I didn’t want to experience that again. I think I had used only half of my available margin (eg. $100k loan + $100k margin available), but I still got a margin call. So I transferred in cash from my wife’s account, since she had a lot of excess margin (eg. only a quarter used).

That solved the problem for a while, but I got another margin call. I solved it the same way, but this time we each have very little margin left. There is a possibility that if the market falls another 5%, I could be under margin again. How did I get in this position? I thought I bought when the market was already low. It turns out that low is relative, since I bought when the TSX was around 12,800. It had already dropped, but it continued to fall.

The reason I got into trouble was that I forgot where margin comes from. Margin comes from the value of the stocks an investor already owns. When I open a margin account and deposit cash, I have no margin (used or unused). But when I buy shares, the shares have a loan value. There are three possibilities: 30%, 50% or no margin. For example, a large liquid stock may only require 30% of its value to be paid in cash, because 70% of the share price is loan value. A smaller, less liquid stock may require 50% to be paid in cash and provide 50% loan value. A penny stock or illiquid holding has no loan value.

What happened to me is not only that my stocks fell in value (like everyone else’s), but that their loan value changed. Some stocks were no longer marginable. Others went from 30% to 50%. In that way, the amount I could borrow in my brokerage account fell rapidly, far faster than the market value. And that’s what produced the margin call.

Margin magnifies the unpredictability of stock prices. Next time, I’ll use far less margin. But for right now, I’m waiting for share prices to recover before I sell and pay back the loan.