The appetite for risk has been gradually growing since the bottom of The Great Recession in March 2009 and have hit a fever pitch recently. This can be both good news and bad news, but I am taking the more cautious approach to interpreting it. The following chart speaks volumes in my opinion.
This chart was taken from the reputable blogger Mish’s Global Economic Analysis. Margin debt has surpassed its April 2010 high and is closing in on the pre-Lehman Brothers collapse level as well. Margin debt is the total amount of money borrowed on margin by investors. It is a terrific indicator of speculative fervor that is taking place in the market. For those that don’t know, margin is money that is borrowed from your broker to buy stocks. It can juice your returns on the upside, but absolutely crush you on the downside.
Contrarian investors look at this number closely to gauge when investor sentiment and “greed†are getting too frothy. When investors don’t fear the downside, they borrow more money and buy more stocks since they are more scared about missing potential upside rather than losing money. I have done it as have most traders I imagine.
There is nothing inherently wrong with using margin, but one must be aware of the potential dangers. You can actually lose more than you have if the position rapidly moves against you. Usually your broker will close out your position, but sometimes the stock dives 50% in a day and you are wiped out and will owe your broker money on top of the cash you lost.
If you are using margin to chase momentum, proceed with caution and consider taking some off the table. The market is looking a bit toppy and you don’t want to be in the hot stocks with margin when the music stops. Months of gains can be wiped out in a day or two. Just some advice to chew on.
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