TaketheFifth 79markets those people may win, getting returns higher than the cost
of the money. In gloomy markets they get crushed.
When the balance in your portfolio falls so that your margin
loans are equal to about half or more of that amount, you have to
put cash in to pay down that debt (your broker gives you a “margin
call”). If you don’t have the cash, your broker will sell some of your
shares—with or without your cooperation. Add the interest expense
and the trading costs to a reversal of Mr. Market’s euphoria to count
your losses; then multiply that by the number of overextended mar-
gin traders and you have the acute slope of a downhill market before
you.
The big margin traders might as well be high-rolling in Monaco
on borrowed money. Loo kno further than the poster boy of margin-
ized day trading to see the stupefying ris kof this strategy. The most
vocal proponent of this high-stakes game is Barry Hertz, the impre-
sario of a company called Trac kData Corporation. Its mar keting
pitch gleefully enthused that investing was easy (“you don’t have to
be a pro to trade like one”), and Hertz advised his customers to day
trade, using borrowed funds.
Hertz at least too khis own (bad) advice to double speculate. So
on Q day (April 14, 2000, when markets plunged), his own brokers
called him to say they needed over $45 million to shore up his mar-
gin account. To do so, Hertz had to pledge over 50% of his shares
of Trac kData.^8 Heed the advice of those like Hertz if you like what
happened to him.
Financial Gambling
You would also do well to remember the tragedy of 28-year-old Nick
Leeson, the so-called rogue trader working for the Singapore branch
of Barings. He funded his trading with millions of dollars of bor-
rowed money, and when the market turned against him, he brought
down Barings, the oldest ban kin England and the one that financed
the Napoleonic wars and the Louisiana Purchase!
Leeson ostensibly was doing arbitrage trading, focusing on dif-
ferences in prices of Nikkei 225 futures contracts listed on the
Osaka Securities Exchange (OSE) in Japan and the Singapore Mon-
etary Exchange (SIMEX). He bought futures on one market and
simultaneously sold them on the other. This was a low-ris kstrategy,
since the two positions offset.
Its success led Leeson to another move, a straddle where he