Is margin trading simple but deadly? The three major pitfalls investors must know

Many investors face the choice between cash and margin trading when opening a securities account. Simply put, cash trading involves buying and selling stocks with your own money; whereas, if you want to short a stock you do not own, you need to borrow the stock from a broker—that is a form of margin trading. Securities lending is a typical example of this type of margin trading.

What exactly is securities lending? Why is it so risky?

Securities lending refers to traders borrowing stocks from brokers, then immediately selling them, hoping to buy them back at a lower price when the stock declines, thus earning the difference.

Sounds simple? But reality is much more complex. Let’s understand the risks of securities lending through a real case.

Short squeeze risk: GME textbook tragedy

In early 2021, game retailer Gamestop (stock code GME) became a major short squeeze target on Wall Street. Numerous investors borrowed and shorted the stock, with short interest reaching record highs.

However, after a third-party investor took a controlling stake, the stock price suddenly skyrocketed. Accounts of those who shorted the stock faced huge losses, forcing them to buy back shares. Many forced liquidations of short positions further drove up the stock price, creating a vicious cycle. This phenomenon is known as a short squeeze.

This case teaches us: The obligation to short sell via securities lending is mandatory—you must buy back and return the borrowed stock at a certain point, and this forced buyback can expose you to uncontrollable risks.

The costs of securities lending are more complex than you think

Imagine you borrow 100 shares of Apple, sell at $191.17 per share, and buy back after 7 days at $181.99 per share. The apparent profit is $918 (ignoring fees). But the costs can eat up most of your profit.

Basic trading costs

• Stock transfer tax: 0.3% (same as regular stock trading)
• Commission: about 0.1425% of the transaction amount, negotiable with the broker

Special costs for securities lending

1. Borrowing fee (interest on securities lending)

Taiwan stock market annual rates are usually between 0.1% and 0.4%, fluctuating based on supply and demand. For example, at an annual rate of 0.4% over 7 days, the borrowing fee is approximately: 0.4%×7/365≈0.00767%.

In the US stock market, it’s much more complicated. Some heavily shorted stocks (“hard-to-borrow”) have annual interest rates exceeding 100%.

2. Margin requirement

For securities lending, 90% of the market value must be deposited as collateral (standard in Taiwan). In the US, it’s usually 100% or more. If the stock price fluctuates sharply, the margin may fall below maintenance levels, prompting the broker to require additional collateral or forcibly liquidate the position.

3. Borrowing fee charged by some brokers

Some brokers charge an additional fee of about 0.08% of the transaction amount.

Cost quick reference table

Differences in securities lending fees among major Taiwan brokers:

• Yuanta Securities: 0.2% (annual rate)
• KGI Securities: 0.2%
• Fubon Securities: 0.2%
• Cathay Securities: 0.2%
• Fubon Securities: 0.1%

Tip: For short-term frequent traders, these costs can accumulate into significant expenses.

Mandatory buyback date: an unavoidable obligation

While securities lending may seem flexible, it is actually strictly regulated. When a company holds an annual general meeting or approaches ex-dividend date, brokers will force you to buy back and settle the borrowed stock by a specified date to update the shareholder register.

For listed companies in Taiwan:

• The first mandatory buyback window is around March each year (two months before the AGM)
• The second window is before the ex-dividend date

If you cannot close your position by the deadline, the broker will liquidate your position at market price, and all costs will be borne by you.

Trading strategies to reduce risk in securities lending

Considering interest costs and mandatory buyback obligations, securities lending is not suitable for long-term investing. The following two strategies are relatively controllable:

Strategy 1: Short-term shorting based on events

If you anticipate that a company’s earnings report will disappoint or a new product launch will fail to impress the market, you can:

1. Borrow and short the stock in advance
2. Wait for negative news to be released, causing the stock to decline
3. Quickly buy back to realize profits

Risk warning: If earnings beat expectations or the new product surprises the market, the stock may gap up, causing unpredictable losses on your short position. Be sure to strictly control position size and monitor stock price movements closely.

Strategy 2: Hedging with a portfolio

This is a relatively conservative approach. For example, you are bullish on a certain oil and gas stock but worry about a broader energy sector decline, so you can:

1. Buy the oil and gas stock (long position)
2. Simultaneously short another underperforming oil and gas stock (short position)
3. The two positions offset each other’s risks

This method requires considering the beta (volatility correlation) of the two stocks, and you can also short multiple stocks to build a more balanced hedge portfolio.

The real reason why securities lending is not suitable for ordinary investors

Securities lending may seem like a tool to amplify gains, but in reality, it amplifies risks. Short squeezes, forced buybacks, margin calls, hidden costs—each can catch investors off guard.

Unless you have:

• A comprehensive risk management plan
• Sufficient funds to cover margin calls
• Clear stop-loss discipline
• Precise market judgment

Otherwise, securities lending is still far from suitable for ordinary investors.