When you trade on margin, you open a position while only committing a fraction of the total cost upfront. The amount you have to pay is based on your trading providers' margin system, the size of the position and the market being traded – the higher the volatility, the larger the deposit required. Margin requirements reflect your leverage, for example, if it is 20 per cent the leverage is 5:1.
You can trade on margin via financial derivatives such as contracts for difference (CFDs) or options, or by spread betting which is not regulated. The growing popularity of these products is spooking regulators, as taking on leverage can make uninformed traders vulnerable to losses they can’t afford. CFD providers are forced to disclose what proportion of their customers lose money, and the numbers range from about 65 per cent to 80 per cent. Concern spiked in January with huge price swings among ‘meme’ stocks, which experts say was amplified by a rush of margin traders on Robinhood.
The surge in GameStop (US:GME) trading activity led to Robinhood's clearing house increasing its deposit requirements tenfold, which is why Robinhood was forced to temporarily suspend trading. This in turn meant GameStop's share price fell, and led to general outrage that private investors had been disadvantaged and a Congressional hearing.
Beyond GameStop, the increase in margin trading in the US looks quite worrying. In January, there was $798bn (£573.07bn) debited in securities margin accounts according to the US regulator, a 42 per cent increase year on year and 144 per cent higher than in January 2011. The concern is that increased leverage in the system makes assets more risky, and when the music stops regular investors’ losses will be amplified.
In the UK, margin trading appears more tame although derivatives providers have been struggling to accommodate a flood of new customers. Trading 212, for example, is not currently taking on any new traders owing to “unprecedented demand”. Last Friday IG (IGG) removed leverage and is only allowing trades on a 100 per cent margin on about 1,000 UK stocks, because its prime brokers have demanded more capital for its positions.
The way IG handled the move has angered a cohort of its customers. Some users were notified on Friday 19 February and others not until the following Monday at 12pm, clearly giving some people preferential treatment. And they forced all existing positions to close within 30 days rather than honouring them.
Oliver Sheridan, who started trading with IG last year, explains their behaviour with the analogy of a parent teaching their children how to play Monopoly: “As the youngsters start to learn the rules, test out their strategies and gain momentum, the parent can see the game beginning to turn, and the parent introduces new rules to protect their advantage."
