Speaking of leverage, it's biting quite a few people on the backside here in Australia. Today's Australian reports that, "Struggling financial engineering group Allco Financial was placed in a trading halt today...The group was last night hit by the forced sale of 22 million shares - about 5 per cent of its capital - and was in frantic talks to prevent the fire-sale of another 23 million shares held by senior executives."
Earlier this week, the Financial Review reported that margin calls hit record levels-and this was before Tuesday. The Fin article cited Reserve Bank data from late last year, so probably doesn't reflect just how bad things were earlier this week. But then, it concept you can see why buying shares with borrowed money is both tempting and risky.
Margin allows you to buy shares without paying for them, at least at first. You even get a tax benefit. It works well when stocks are going up. Free money to buy rising shares!
It doesn't work so well when stock prices fall. As the value of the shares fall, you must either repay the loan or sell the shares. There was a lot of selling earlier this week. It tells you how confident investors were. When you're playing with other people's money, slog away. When it's your own however...
Dan Denning
The Daily Reckoning Australia
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About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.
Comment by novosonic on 24 January 2008:
excellent advice dan, it should be tattoed on everybodies hand when they open a stock account.
Comment by Malt on 25 January 2008:
As Marathon shares tumble and their license on the cards to be revoked, major changes afoot in mineral sector particularly South Australia which is causing headaches for Canberra. Love to see feature on current state of play re resources sector and China. Great Site!