‘You Lose Money Even If You Guess the Direction Right’… Warning on Debt-Fueled and Leveraged Trading Amid Market Downturn

Economist Hong Chun-wook is cautioning investors against the dangers of leveraged trading and the "negative compounding" effect, particularly in the current climate of heightened stock market volatility. He highlighted these risks during an appearance on his YouTube channel, 'Hong Chun-wook's Economic Lecture Notes,' on August 2nd.

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If you have 10 million won in stocks, you can borrow an additional 1.5 to 2.5 times that amount, or 5 million won, and use that money to buy more.

Hong presented data on the ratio of margin debt (B2 credit balance) to U.S. GDP, explaining that it represents borrowing funds to buy more stocks. He pointed out the primary issue with margin trading: investors often "go all-in" on the hottest stocks due to impatience. This strategy carries a significant risk, as a mere 20% to 30% drop from the purchase price can trigger a margin call, forcing liquidation and potentially removing the investor from the market even during a temporary dip in an overall upward trend.

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Impatience leads to going all-in on the hottest stocks, which is the first problem.

The economist also warned about the cascading effect of forced selling, known as reverse trading. When investors see others being liquidated, they may panic and sell their own holdings without considering price or value, leading to a collapse in supply and demand. This can cause some stocks to plummet for days. Hong cited the example of SK Hynix and inverse products to illustrate the "negative compounding effect." Even if an investment loses 50% on the first day and then gains 20% and subsequently 25%, the initial large loss makes it difficult to recover, resulting in losses even if the underlying asset price eventually returns to its starting point.

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When you see others being liquidated, you might think, 'I need to sell before I become like that,' and sell without looking at the price or value, leading to a collapse in supply and demand.

"Why would you invest in products that are expensive and have a negative compounding effect?" Hong questioned. He advised investors to pursue steady compound growth through regular stock investments, index investing, or asset allocation and rebalancing strategies, rather than risking significant capital on volatile, leveraged instruments.

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Even if the price goes up and down and stays in the same place, you can only lose money on both sides.