There was hot news a few days ago. A Tencent cloud database expert in the technology circle borrowed money from many colleagues to speculate in stocks. However, the market continued to fall. In the end, the paper could not contain the fire and it exploded.
The essence of borrowing money to trade stocks is to use leverage, and everyone says leverage is a double-edged sword. I think a more accurate metaphor should be a double-edged sword without a handle. When using leverage, you are holding it directly on the edge and waving it. Sword, but the hand will keep bleeding. After all, there is almost no free leverage in reality, so the time you can use the leverage is related to the speed of blood loss, and leverage is the enemy of time.
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People who use leverage are generally more confident, and their confidence often comes from past success.
Let’s talk about a few famous leveraged liquidation cases. The most recent one is the Korean Bill Huang who speculated in US stocks with 5 times leverage last year. The overall decline only needs to reach 20% to liquidate his position. However, one of his holdings happened to have a sharp decline, and the margin was insufficient, so he needed to sell stocks to replenish the margin. If he is an ordinary person, his position will not be liquidated. But he is not an ordinary person. His market value is 80 billion US dollars, but most of his holdings are Chinese concept stocks with a small market value. This sale triggered a chain reaction: sell If the stock price falls, the stock price falls, and the margin is insufficient, you need to continue selling, a vicious cycle, and eventually the position will be liquidated.
A further example is the story of Long-Term Capital in the United States in the 1990s. Long-term Capital's team is known as the "Dream Team" and includes two Nobel Prize winners in economics. The person in charge is the father of Wall Street bond arbitrage. Long-term Capital has gathered a group of top smart people to use mathematical models and algorithmic data to conduct market-neutral arbitrage through hedging. It started smoothly, with returns as high as 28%, 42%, and 40% in the first three years.
Hedging neutral arbitrage actually makes very little money from each transaction. The reason for such a high annual return is the extremely high leverage, with the leverage ratio ranging from 3 times to 100 times. If leverage is not used, neutral arbitrage will have very small fluctuations under normal circumstances and you will not make much money. Corresponding to the normal situation, there will always be abnormal situations. In 1998, the Russian sovereign debt default crisis occurred. Market fluctuations were greatly amplified, which directly broke through the hedging model of long-term capital and went bankrupt overnight.
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We also often use leverage in our daily lives, mainly for consumption. For example, buying a mobile phone, a car or a house in installments. Using leveraged consumption consumes future income and obtains enjoyment and satisfaction in advance. This is the benefit it brings. The disadvantage is that there is uncertainty in the future, and you may bear a heavy burden when bad situations arise.
When I was still young, I was full of hope and confidence in the future, so I also used leverage to spend. The first car was purchased in three-year installments. Just after I took delivery of the car (in mid-2014), the stock market, which had been bearish for several years, suddenly broke out into a bull market. But at that time, except for the debt, I had no funds to invest in this bull market. After hesitating for a while, I came up with a way to overdraw my salary income in the next year to invest in the stock market. But it was a bit late. The bull market bubble soon burst, ushering in the stock market crash.
The leveraged journey through the stock market crash was very painful, but fortunately, the one-year overdraft was quickly paid off, and I learned a lesson. A few years later (at the end of 2017), I bought another apartment for study and improvement reasons. At that time, I felt the best in my career. My income and rank had reached a record high, and the company’s stock price had just made history. A new high, the economic situation feels very good, and I did not expect that there will be a huge gap next year.
Buying a house with a loan is a one-time expense that leverages your income for the next 20 years. But how long can we maintain this record-high income level in the future? Looking back now, it turns out that it is only a few years. For me, the gap in 2018 was a preview of deleveraging. From then on, the country began to promote deleveraging, and I also started deleveraging: there is no more installment consumption, and all liabilities except housing loans have been paid off. With a living reserve of more than two years, we have arrived at a year 2022 that feels even worse than 2018.
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Many people not only use leverage to consume, but also use leverage to invest in stocks. It is already very difficult to achieve an average annual index return of 8% in the stock market. So after deducting the capital cost of leverage, how much room for error or profit is left? Newcomers always enter the market in a bull market (I entered the market as a newcomer in the bull market in 2006). Newcomers are often fearless and confident, and usually end up being either eliminated or defeated. More than ten years later, if I am still not wiped out in the stock market, I should be convinced.
The result of being beaten is to become conservative and pay more attention to risks, especially "tail risks". What is tail risk? If leverage is used, tail risk will be the risk that will blow up your position. In the normal distribution curve, the tail is the section where the probability seems to be very small, but the consequences of its occurrence are very serious, commonly known as a "black swan" event.
But in fact, everything in life has tail risks. For example, flying has the tail risk of air crash. We can only try our best to avoid unbearable results and consider the probability of this tail risk.
If you want to invest with leverage, do it when you are young and don’t have much money. At this time, the tail risk of leveraging is nothing more than losing money (not much money), the marginal benefit may be greater, and you can learn something more truly regardless of whether you make or lose. I think this investment path is a typical situation of "I've heard a lot of truths but still can't live a good life", and I have to experience it myself.
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Leverage is just a tool; sometimes it’s not that you don’t use the tool well, but that you can’t control yourself.
