When the stock market rises, investors buy stocks on margin (i.e. borrow money to invest) in an attempt to get as vested as possible in the market in order to profit from its expected rise. At times like these, however, margin calls (i.e. requirements to pay back debts) cause investors to have to liquidate their margin positions. Here’s a chart showing NYSE margin debt over the last year up to October of this year:
As far as indicators go, it does not appear as though investor sentiment can get much worse. This pattern is nothing new, however. When we looked at margin borrowing in the last recession, we saw a similar pattern to this one. This doesn’t necessarily mean we’re at a stock market bottom, but it does indicate that the worst of the selling may be over. After all, if there isn’t much margin debt left, it can’t drop by all that much.
Margin debt may be considered useful as a contrarian indicator for those who like to buy when others are fearful, and sell when others are greedy. For such contrarians, this indicator suggests now is a time to buy.