CARTERVILLE, IL - Deadly Debt?





Today I will answer a question, “Is margin debt continuing to increase while the markets make new highs?” To answer, I will revisit the definition of margin debt and show its current relationship to the market.



First, let’s revisit the definition for margin. Margin is when traders/investors borrow funds with their current funds or securities as collateral. If traders use borrowed funds to buy additional securities and they go up, then they can leverage their gains. Of course, if the price of the margined securities drops, the opposite can happen, and traders can lose money twice as fast. I stress staying away from using margin in your trading and investing strategies period.



Increasing margin levels is not the problem. The exchanges like increased margin because it allows additional money to be traded.  When forced selling from margin calls hits, it can spur rapid stock market declines as in 2000 and 2007. But when this happens, many emotionally focused investors can get trampled. Hopefully, traders that follow my systems have already gotten out and locked in their hard-earned profits.



Let’s review data from Doug Short at advisorperspectives.com, featuring the latest margin debt data (April 2014) for the New York Stock Exchange and compare it to the recent (May 20, 2014) market action. Per the chart, we can see the action of the S&P 500 (blue line) from 1995 to the present (top) and the NYSE margin debt (red line). Note the NYSE margin topped early in 2014.  Previously margin tops (red line) preceded market tops in 2000 (market top) and in 2007 when the market made another top.

 



Does this prove the S&P 500 is ready to drop? My answer is no. This decrease in margin debts tells me the institutions were taking profits. There is no way to know if profit taking will continue. When the updated margin reports are released, I will give an update.



As I type, the S&P 500 is trading at new highs while weekly momentum indicators continue to show decreasing strength. Keep in mind the chart shows after market tops, heavy selling happens and happens fast, represented by the sharp downturn in margin amounts at the NYSE.



Finally, note the market topped seven years later in 2007 from its previous 2000 high. How many years has the market rallied since the previous 2007 high? You do the math--we are going on seven years since the previous highs. I hope this gets your attention.



Plan your work, work your plan and learn to share your harvest!





Source: Dshort.com, davidoengland.com.



Full Disclosure-I do not hold any of the securities listed in this column.



DAVID O. ENGLAND is the founder of the Eye on the Market-Training Academy and retired associate professor of finance at John A. Logan College. This column is presented for educational purposes only and is not intended as financial advice. For questions, contact England at thetraderseye@gmail.com.