kcchongnz blog
Margin financing (again) in Shanghai Stock Exchange kcchongnz
[A customer strolls into a bookstore, goes the popular Chinese joke, and tells the salesperson: “I’m looking for a book with no killers, but much bloodshed; with no love, but great regret; with no spies, but constant paranoia. Can you make a recommendation?” Just one, the salesperson replies: The State of the Chinese Stock Market.
Then there’s this one about a Chinese investor: “In the morning, he watches the K-line graph,” which tracks the perambulations of a share’s price. “In the afternoon, he goes to the hospital to watch his electrocardiogram.”]
I recall about a month ago, I was saying it is alright if one uses margin finance on his own but to advocate this margin financing in stock investing to the general public is not a good thing. In fact it is very bad. If you care to goggle in i3investor, there are numerous articles teaching the public how to use margin financing to enhance the return from the stock market. Come on, what kind of “wisdom” are you trying to disseminate to the public in general and our next generation in particular?
Someone also directed this statement to me a month ago:
“Dear KC Chong,
To me, it is a wrong strategy not to use margin financing if the market condition is very bullish. Opportunity hits but once, I will make full use of this good opportunity. In Shanghai stock market now, the rapid rise is because most investors use margin financing. You tell the investors in China now, using margin financing is very bad, I believe many investors will scold you that you are a stupid investor.”
“I am sorry ... I repeat ... I am sorry to say that a small investor like you will not use margin account, it does not mean that big investors will not use margin account to win big. May be I had spoken to all big investors only.
I purposely sending out a special note to survey all my big clients and my subscribers, most of them are using margin accounts. “
Felt stunned when I read the word “scold”, derogatory “Stupid”, and the discriminatory “a small investor like you” used.
When those statements were made about a month ago, the Shanghai Index was at 5023 points. I just peeped at Yahoo Finance, it closed at 3687 today on 3rd July 2015. The index lost 27% in less than a month. What about the loss of individual small cap and mid cap shares?
Here I just happened to read a good article in i3investor.com on as shown in the link below.
“[duit's] - China Shanghai Composite Index, COLLAPSE?”
http://klse.i3investor.com/blogs/chinashanghaicompositeindex/79337.jsp
So would the Chinese investors scold me “stupid” from the statement I made a month ago, that it is unwise to speculate in the stock market using margin finance, just because the statement comes out from “a small investor”?
The Pros and cons of leverage
It is a good practice for corporation to borrow money to do business and earn a better return for its shareholders. No argument about it. But this example in corporation should not be used to encourage the general public for their personal investment in the stock market.
Table 1 below shows the one-year holding period returns of your equity with different scenarios of total returns with a leverage ratio of 1 to 1, i.e. you have RM1 and you get a margin finance of another RM1 from the investment bank. The costs of the margin financing is extracted from the post below with the facility fees of 0.5%, interest rate per year is 4.85% and other costs of 1% for a holding period of one year as shown.
http://klse.i3investor.com/blogs/humblepie188/79058.jsp
Table 1: Costs and returns using margin financing for a one-year holding period
You only start make money if your portfolio goes up by 4% as shown in scenario 2 in Table 1. Below that you lose money because of the financing and transaction costs. You will make exaggerated profit of 53% if your stocks go up by 30%, or a neat RM530000 as shown in scenario 1. How nice! However, if the return of total investment is minus 10%, your loss will be amplified to minus 27%. What if your portfolio is invested in the broad Shanghai Index which lost 27% in just the past one month? You would have lost RM607100, or 61% of your own money in one month as shown in scenario 5!
But that is just the drop of the broad index. I am sure there are many small and mid-cap stocks which have dropped by a lot more than the broad index. If the drop of the portfolio is say 47% as shown in scenario 7. You would have lost all your money and “pok kai” or bankrupt!
Not possible? Go and search the individual stocks there, and I believe there are many of them.
So should the Chinese investors scold this “small investor” “stupid” when I said it is not advisable to use margin finance to punt in the Shanghai Stock Exchange a month ago? I actually didn’t know how the market would turn out then, but it is just a good investment maxim of not to use margin finance to speculate in the market for the general public.
It’s great to borrow a cow and selling the milk, but not until the cow runs off. Now you’re stuck. You owe a cow and don’t have one to return, and no milk. The risk of leverage is investing that debt and losing what you borrowed, which can wipe out any profits, or even your entire capital.
Anyone lived through the experience in 1997-1998 during the Asian Currency Crisis and the political turmoil at home and saw how the KLCI and the Second Board Indices fell like waterfall and imagine the devastations caused by margin financing?
http://klse.i3investor.com/blogs/kcchongnz/73675.jsp
Have you heard of the US sublime crisis just a few years ago when the liquidity in the market just dried up completely? And what happened to those who used margin financing?
http://klse.i3investor.com/blogs/kcchongnz/74057.jsp
Hack, even banks won’t want to lend to each other! The two very established investment banks in US, Bear Stearns and Lehman Brothers just went kaput because nobody was willing to provide credit and liquidity to them. The four-sigma or six-sigma event can happen much more often then what is suggested in the normal distribution.
Or the Dotcom Bubbles in 2001 when many individual technology stocks lost more than 90%?
http://klse.i3investor.com/blogs/kcchongnz/73859.jsp
And many more?
http://klse.i3investor.com/blogs/kcchongnz/73543.jsp
I personally don’t even advocate one should put all his money in equity, especially at this time when the stock market is not considered as low at this juncture. More so I would never suggest to anyone to borrow and use margin finance to invest. It is a good practice to have a good assets allocation; some money in the stocks (and diversify the stock holding), some in fixed income, and some in properties etc. But never in gold, I mean like Genneva Gold.
Overconfidence has no place in investing for long-term wealth building. It kills, it often does.
Is the future knowable or unknowable? I feel I don’t know what the future holds and hence I will do differently; diversifying, not levering, staying high in the capital structure, and generally girding for a variety of possible outcomes.
And here are what the religious people say:
“The Lord will open to you his good treasury, the heavens, to give the rain to your land in its season and to bless all the work of your hands. And you shall lend to many nations, but you shall not borrow.” Deuteronomy 28:12
“The taking of a loan is not something that a respectable individual would do without necessity, to create a burden upon themselves. When it is a necessity, then people should seek to assist their relatives and Muslim brothers, according to one’s capability.” Muslim teaching.
“Rivers can sometimes fill their banks, but the wants of human beings can never be filled.” – The Buddha
K C Chong (3rd July 2015)
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Discussions
11 people like this. Showing 48 of 48 comments
The speed of the collapse in both shanghai and shenzhen bourses is also due to excessive use of margin financing in both markets. A correction triggers margin calls which then causes force selling that drags the market lower thus triggering even more margin calls. It's a brutal self reinforcing cycle. Thoso who have no fear of leveraging should pay heed to China.
2015-07-03 21:58
Before the market go bust, it tends to hit high creating euphoria or sense of overconfidence for syndicates to make their exit! Such is the case of China and Hong Kong market that we witness now! We did experience such exuberance back in October last year! My assessment is, bursa will hit 1900 or even 2000 before going bust! Saying so, it is better to be cautious how we invest going forward! Margin financing is all about multiplying you returns in shortest possible time! And i can assure you as bursa hit that sweet spot where stocks keep going higher and higher, limit up is daily affair, many will lose their sense of cautiousness! If you had such minor experience back in October, i can tell you, be very careful once these exuberance come back! Few weeks back, many punters in China may find making money so easy that their carelessly took margin financing! Now, do remember to think with you head when bursa turn into big casino again! It's too recent for me when i gave forewarning about major correction that so many came to scold me! So what OTB saying is true!
"You tell the investors in China now, using margin financing is very bad, I believe many investors will scold you that you are a stupid investor.”
2015-07-03 22:58
Malaysia with so many political issue plus many people been gone through fews time of burning experience, it may not have the chance for klse to go high as 2000.
2015-07-03 23:33
水能載舟，亦能覆舟
Water can carry boat also can overturn boat. All depend on how you use it. The example quoted above is consequence of people misuse share margin to gamble in equity market. The original objective of share margin is designed for people to invest in stock market. If someone misuses it for gambling, that is not the fault of share margin, but the people who misuse it.
2015-07-04 11:31
Posted by fortunebullz > Jul 3, 2015 10:58 PM | Report Abuse
"You tell the investors in China now, using margin financing is very bad, I believe many investors will scold you that you are a stupid investor.”
That is the problem. When they made some easy money using OPM, mostly due to luck, they become irrationally exuberance, overconfident, arrogant, looking down on others, scold others of some sensible comments. There are people who believe and condone the above behavior, having the opinion that it is the right thing to do, to scold for giving an opinion of wisdom, and it is cool thing to do.
2015-07-04 13:09
We have to be prudent when investing because we do not want to contemplate jumping off a high building,in front of a train or a cliff when things take a bad turn in the stock market. Any adverse financial situation will affect the whole family,so be more responsible and keep in mind the worst case scenario. Avoid the worst case scenario,as you cannot afford for this to happen to you. Then think about making money in the stock market.
2015-07-04 14:00
Cheap but still no money to buy so borrowed until no money to service loans.
2015-07-04 15:23
Relax,just for laugh................
青菜不买买股票，
大妈赚得哈哈笑。
股市一转就大掉，
如今大妈找楼跳。
以上所述，纯是虚构，
如有雷同，实属巧合。
2015-07-04 15:48
Instead of Margin, we can turn to company warrants and structured warrants. For example, Buy GENTING-WA is kind of buy GENTING with loan and the interest rate is only 4.1% only, Buy FBMKLCI-C4 is kind of buy whole basket of blue chip and the interest rate is 6.7%. The beauty is no margin call and no need to be responsible for any further losses beyond the warrants purchase money.
2015-07-04 17:07
Posted by Gheekong > Jul 4, 2015 02:00 PM | Report Abuse
We have to be prudent when investing because we do not want to contemplate jumping off a high building,in front of a train or a cliff when things take a bad turn in the stock market. Any adverse financial situation will affect the whole family,so be more responsible and keep in mind the worst case scenario. Avoid the worst case scenario,as you cannot afford for this to happen to you. Then think about making money in the stock market.
10 likes!
2015-07-04 17:09
ks55,
Thanks for your real life experience. Only people who have gone through a real crisis appreciates the perils of margin financing.
Margin financing in stock investing is never designed for the well being of ordinary investors, but for the investment bankers, brokers to make more money from them from bigger transactions and hence the higher costs, interest costs, broking costs, facility cost etc.
2015-07-04 17:16
Ntpboon
I always like your Chinese poems. You are a talented guy.
Posted by Ntpboon > Jul 4, 2015 03:48 PM | Report Abuse
Relax,just for laugh................
青菜不买买股票，
大妈赚得哈哈笑。
股市一转就大掉，
如今大妈找楼跳。
I also like cpng's wisdom in Chinese.
Posted by cpng > Jul 3, 2015 09:44 PM | Report Abuse
中国股市崩盘,随时令中南海晃动。
当年国民党军3~400万雄师,在抗战胜利后不到4年的光景,被不到百万解放军吃光。
如今物换星移,中国大陆今年6月底的股民9000万人,还多过共产党。
没有买卖,就没有伤害,但当大家的身家性命都压上去时,股市的三长两短,中南海坐立不安。
2015-07-04 17:37
westinee,
Good sharing. Yes, some people made killings in the stock market, not sure how many really did that. So they boast around and keep on teaching (yes, this very word was used) the general public to use margin finance to try to make big too. Your point is you have seen many suffered terribly as a result of using margin financing in 1993, so have ks55 in 1998, GheeKong, soojinhou etc.
So is it an appropriate thing to do by keep on telling the general public, the newbies, our younger generation to use margin finance to speculate in the share market without caring about the possible consequence which you all have shown are real possibility?
2015-07-04 18:43
Preaching margin financing to the mass public without a thorough discussion on worst case scenario is unethical and irresponsible. I know because my uncle lost his entire life saving in the 97 crisis. Thank u kc for speaking up even though u might have stepped on a few toes in the process
2015-07-04 20:21
I always appreciate and value Mr kcchongnz's comments. He is very knowledgeable & experience in share market and financial analysis of Bursa counters. I always like to follow his comments.
2015-07-05 13:47
I believe we invest our own money to buy shares. Share margin financing is very risky. You can make a lot of money during a bull run but when the bear comes, you can lose all your gains in a matter of 2 weeks. If you had bought the wrong counters, you will also lose all your investment ending up still repaying the bank loans for years to come. Do not be greedy. I have experienced the stock market crisis in 1987, 1993, 1997/8 and 2011. I am still around and sleeping well simply because I don't use margin financing. Banks are ruthless, you are at their mercy during a bear market.
2015-07-05 14:30
头文字D
阿木：老豆，我要买GTR！
老豆：我买部Benz俾你吖！
阿木：我要GTR！！
老豆：加只劳吖
阿木：我要买GTR！！！
老豆：但系你寻晚差D死哦。。。
阿木：寻晚如果揸GTR，我使抄？
老豆：你揸GTR你死咗啦。。。
Initial D
Amu: Dad, i want buy GTR!
Dad: I buy you a Benz!
Amu: I wan GTR!!
Dad: And a Royce
Amu: I want buy GTR！！！
Dad: But you almost die yesterday...
Amu: If drive GTR yesterday, where will accident?
Dad: You die already if drive GTR...
2015-07-05 17:14
Forget all about just go to popular book store n buy the cold eye book vol 1 it's worth investing in it even it is simple you won't regret reading it. Just to share I do not know s
Chinese I am banana, I still giving my self a chance to read his works. Worth reading. Secondly not forgetting bro KC and many good authors like chengyk, windscopo.
2015-07-05 17:31
Posted by paperplane2 > Jul 5, 2015 05:46 PM | Report Abuse
Kc, would you recommend holding more cash now?
Good question. My answer to your question is
1)Are the stocks you have chosen follow the principle of the Dhandho Investors; i.e. Heads I win, Tails I don't lose much", or following The Greater Fool Theory?
2)Are you able to sleep well at night?
If you are able to answer well the above questions, you should be able to decide for yourself. Nobody can tell you what to do.
2015-07-05 18:02
What is the purpose of this blog? Talking bad about buying on margin?
Does anyone here invest in Shanghai Stock Exchange(A & H shares)?
Why no new stocks recommendation from KC Chong? His last stock recommended is Elsoft. Is it doing well?
2015-07-05 18:28
Forget all about just go to popular book store n buy the cold eye book vol 1 it's worth investing in it even it is simple you won't regret reading it. Just to share I do not know s
Chinese I am banana, I still giving my self a chance to read his works. Worth reading. Secondly not forgetting bro KC and many good authors like chengyk, windscopo.
2015-07-05 19:17
donfollowblindly, KC is a value investor and of course his investing style is on a long term basis. He posted his analysis in April. why don't we come back in a year time and see how well will elsoft perform? Btw, last quarter report is superb. Bro, just a diff investment strategy from you may be? I think all of us would appreciate if you could share similar analysis like what KC did FOC for us (be it fa, ta, speculation or what not). :)
2015-07-07 01:59
Kc,i notice not much ppl do arbitrage in bursa. Does this proof our mkt inefficient?
2015-07-11 23:51
Posted by paperplane2 > Jul 11, 2015 11:51 PM | Report Abuse
Kc,i notice not much ppl do arbitrage in bursa. Does this proof our mkt inefficient?
I would say market everywhere is not that inefficient. There is little or no risk free arbitrage opportunity around, and if there is any, there are a lot of limitations for the arbitrage opportunities, for example cross holding of companies making it hard for others to gain control, or the risk reward is not that attractive.
2015-07-12 02:40
If now I spot an opportunity to arbitrage to gain near 30%return,shaall I do so in big scale?
2015-07-12 03:12
Posted by paperplane2 > Jul 12, 2015 03:12 AM | Report Abuse
If now I spot an opportunity to arbitrage to gain near 30%return,shaall I do so in big scale?
I highly doubt you have any risk free arbitrage opportunity. If you are talking about risk arbitrage which is likely the case, then you have to view each circumstance.
2015-07-12 10:38
Technically it is called risk free when you have warrant in discount. As you can convert and sell the mother soonest. Provided of course you can convert fast.
2015-07-12 18:13
Posted by paperplane2 > Jul 12, 2015 06:13 PM | Report Abuse
Technically it is called risk free when you have warrant in discount. As you can convert and sell the mother soonest. Provided of course you can convert fast.
This is definitely a risk arbitrage, unless you can short sell the underlying stock. I call it execution risk. The advantage of it is your potential gain as you said is high at 30%, quite a wide margin. However anything can happen before the whole conversion exercise is carried out and completed, probably in two to three weeks time.
I got burned before many years ago when a similar situation happened on a stock and its warrant call Country Height with the cunning and manipulative major shareholder and manager. So watch out who is behind the company, if he is trustworthy. It is hard to find a big fat frog jumping all around nowadays.
2015-07-12 19:09
I agree, thts why I am in cautious now. Such a great deal I was thinking true or not. AlThough fundamental of company seems OK
2015-07-12 19:49
Hi KC ,100 % agree with what you say that never use margin finance to invest,we never know how long the market will bullish . and we human greediness is never enough . history already tell a thousand words by itseft...
2015-07-23 14:14
If I have 100K value of stock, with 150K margin facility. I only used up 50K, where debt is about 33%, which is far away from 60% margin call. Moreover, I buy in when the index drop like 20%. It then give me higher chance of not kena margin call, and higher in return.
What do you think of this strategy?
2015-07-24 18:03
Posted by Henry Tan > Jul 24, 2015 06:03 PM | Report Abuse
If I have 100K value of stock, with 150K margin facility. I only used up 50K, where debt is about 33%, which is far away from 60% margin call. Moreover, I buy in when the index drop like 20%. It then give me higher chance of not kena margin call, and higher in return.
What do you think of this strategy?
Good question. But before I give you my opinion, let me ask you some questions.
1) You request for 150k margin facility, so do you have to pay a start up fee as a percentage of 150K?
2) If the above is yes, what is the rationale of getting that margin finance, pay full fee, but only use 1/3 of it?
3) In Shanghai index, in one month the index dropped more than 30%. What do you think an individual stock will drop?
4) If your stock drops by 40%, what will be your loss? Let us not bother whether there is a margin call or not first.
5) If your equity loses by 50% because of margin finance, how much your stock must go up to break even?
6) Can a stock drop by 50% when the market drops 30%, or even 70% when forced selling of others are involved?
7) Why do you say if the market drops 20%, it give you higher chance of higher return? Can't it keep on dropping, when margin calls are all over?
8) Can you concentrate in your work with the fear of losing money?
9) Can you sleep well?
10)Can you ever recover because of the amplified losses due to margin financing even if the market recovers eventually?
2015-07-24 19:31
hi KC chong ,then how about if the index drop to very low just like 2008 crisis , let's say the klse index overall PE ratio is about 6-8 only ,and all the stocks you study is very cheap too .and you have no extra cash in hand,so do you think it is wisely to put margin finance at this moment .remember that such a good chance is not appear always...
2015-07-29 12:14
Posted by citychew_1886 > Jul 29, 2015 12:14 PM | Report Abuse
hi KC chong ,then how about if the index drop to very low just like 2008 crisis , let's say the klse index overall PE ratio is about 6-8 only ,and all the stocks you study is very cheap too .and you have no extra cash in hand,so do you think it is wisely to put margin finance at this moment .remember that such a good chance is not appear always...
If index drops to overall PE ratio of 6-8, there will be a lot of good buys then. Invest big, but with your own money. I will never use margin finance, simply because even the market is very cheap, you will never know if it will go down further. If you are on margin, and if the market drops another 30%, you will lose all your money, plus still owing to the banks. The market will eventually recover, you will be okay if you invest with your own money. But if you get caught with margin calls, it is hard for you to recover,simply because all your capitals are gone.
Won't happen like that? Read this. Ths thingy happens relatively often.
http://klse.i3investor.com/blogs/kcchongnz/73675.jsp
Investing is, well investing for building long-term wealth, not speculating.
2015-07-29 13:34
Hi KC ,good example from the link you illustrate above ,so to all the newbies and learners ,being an intelligent investor ,we must always keep some extra cash in hand especially in the expensive market. the higher the market ,the more cash we have to keep in order to invest big when the market is crash. i think this is the only way to solve this issue .
2015-07-29 21:12
Just had a peep on the Shanghai Stock Exchange. It closed at 3663 on July 31st 2015. Just less than two months ago on June 12th, it was at 5166. That means the broad Shanghai Index dropped by a whopping 30%, in less than two months!!
What do you think an individual high beta stock will drop? Could it be 50%?
Easy. I would think many would have dropped by 60%, 70% or even more!
What would happen to those who used say 50% of margin financing? Bankrupt!
What happen to the market sentiment? Fear, sleepless nights, begging for money from friends and relatives to cover margins.
What would happen to the stock market in Shanghai? Long term damage. All investors will suffer.
What happen to families of speculators using margins? Broken!
The big problem is the use of margin finance, the encouragement by the brokerage firms, the investment banks, all propagating that it was so easy to make use of other people money to make money. If you didn't do that, you would be branded as stupid! It was the problem of the Communist government for not controlling this weapon of mass destruction, the margin financing in stocks speculation.
2015-07-31 18:03
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This book is the result of the author's many years of experience and observation throughout his 26 years in the stockbroking industry. It was written for general public to learn to invest based on facts and not on fantasies or hearsay....
cpng
中国股市崩盘,随时令中南海晃动。
当年国民党军3~400万雄师,在抗战胜利后不到4年的光景,被不到百万解放军吃光。
如今物换星移,中国大陆今年6月底的股民9000万人,还多过共产党。
没有买卖,就没有伤害,但当大家的身家性命都压上去时,股市的三长两短,中南海坐立不安。
2015-07-03 21:44