We’re learning this in school, but I don’t quite get it. My teacher said everyone was buying bank loans for stocks. The higher the stock prices rose, more loans people bought. The day the stock market crashed, 12.9 million stock were sold. Why were they all of a sudden sold? Could you please explain this to me?
People bought on margin during those days. This means you can take a loan out for a percentage of the trade. Today some brokers will let you buy on 2:1 margin, meaning if you have $10,000 they will let you buy $20,000 worth of stock.
Back in those days people were able to buy with 10:1 margin, meaning if you have $10,000 you could have bought $100,000 worth of stock.
In 1929 stock prices had risen way beyond their true value and were bound to pull back.
When they did people paniced afraid that they were going to lose all of the money they originally invested with or more because of margin. So there was a lot of selling that took place, mostly because people were afraid of what would happen if they hung onto their positions.
What your teacher is referring to is "buying on margin," in other words using borrowed money instead of your own money to buy stocks. The problem with buying on margin is that people tend to panic sell when the market goes down. In 1929, the market started to decline (which markets tend to do) and the big investors who had bought on margin started to panic and sold. That drove the market down further, and more people on margin sold and that forced prices lower, creating more panic selling.
References :
Buying on margin today is allowed at 2:1 leverage, or 50% margin reguirement. Some brokers will go less. That is considered risky.
At 50% margin, you can buy twice as much stock as you would normally. If the account drops below a certain amount, you get a margin call to deposit more money or the position is liquidated by the broker. Problem is, when the market goes down, your stock has only to decline in half to completely wipe you out because you are leveraged 2:1, but you would get a margin call much sooner than that.
In 1929, the margin requirement was only 5%, not 50%. People were so highly leveraged, that any little decline caused a huge loss in their account. Sure they panicked, when they got a margin call requirement that they deposit more money that they didn’t have.
The stock market didn’t go down due to panic until much later, it was the margin calls initially due to over-leveraged positions, borrowing money to buy stock. And yes, that REQUIRED selling due to margin calls, not panic selling, drove the market down further until panic ensued.
References :
People bought on margin during those days. This means you can take a loan out for a percentage of the trade. Today some brokers will let you buy on 2:1 margin, meaning if you have $10,000 they will let you buy $20,000 worth of stock.
Back in those days people were able to buy with 10:1 margin, meaning if you have $10,000 you could have bought $100,000 worth of stock.
In 1929 stock prices had risen way beyond their true value and were bound to pull back.
When they did people paniced afraid that they were going to lose all of the money they originally invested with or more because of margin. So there was a lot of selling that took place, mostly because people were afraid of what would happen if they hung onto their positions.
References :
http://www.stocks-simplified.com/What-caused-the-great-depression.html
No more buyers…everybody was on the same side of the trade….if everybody is on the same side of a boat…it tips over.
In order for stock price to keep moving up…there has to be somebody on the other side of the trade that is willing to pay a higher price than you did. When there are no more buyers…the previous buyers feel (emotionally) that they paid too much. Everybody runs for the exits at the same time…think about somebody yelling fire in crowded movie theatre….panic.
This cycle repeats all throughout history….Tulips anyone?
References :
Hello, I am Natasha Willmoore, from North Carolina, I have been looking for a loan of $167,000 to increase on production of fruit juice but was scammed, when one of my staff told me of a private lender who gave him a loan of $85,000 to complete his education. I contacted him and got the loan same day, my neighbour who was out of job also got a loan of$40,000 yesterday to start a business. Mr. Bruce Llyods is today my godsent angel. If you need a loan just contact him at brucellyodsloanfirm@gmail.com
References :