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…
The Daily Reckoning Australia