No FX this time, but to important to avoid.
Leverage is dangerous for many reasons, but the dangers of an excessively levered market are really rather simple to understand. As DB says, it creates an environment that can lead to a disorderly unwinding of excessive risk:
“Margin debt can be described as a tool used by stock speculators to borrow money from brokerages to buy more stock than they could otherwise afford on their own. These loans are collateralized by stock holdings, so when the market goes south, investors are either required to inject more cash/assets or become forced to sell immediately to pay off their loans – sometimes leading to mass pullouts or crashes.”
Margin debt creates the sort of unstable environment that makes a snowball effect much more likely than it would be in an environment without margin debt. If you recall 2008 you likely remember hearing about how many fund managers were “forced liquidators” of portfolios. That was, in large part, due to the excessive leverage.
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