Margin debt is a big force behind stock prices. It’s the great accelerator, on the way up and on the way down. When investors buy stocks with money they don’t have and that the broker creates for them, it drives up stock prices, and makes room for more margin debt as higher stock prices allow investors to borrow even more against the same number of shares. It’s wonderful.
But when stocks tank, already spooked investors may be forced to sell to pay down their margin debt to stay within the limit. Forced selling drives down prices further, which begets more forced selling. Some of that happened last week, and particularly this Monday when the Dow plunged over 1,000 points at the open.
Margin debt has a nerve-racking habit of running up sharply and then peaking right around the time stocks crash. In the last sixteen years, there have been three majestic spikes, each greater than the prior one.
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