Losing Money on the Margin

Margin trading is popular with retail investors around the world. To limitthe scale of these investors’ potential losses, regulators impose a system of collateralrequirements and margin calls. We show in this paper, however, that the collateralrequirement imposed by margin calls results in negative expected returns for thesetraders whilst also inducing positive skew in the returns distribution. Investments inassets with symmetric returns, when traded on margin, instead offer limited losses and asmall chance of a large gain, much like lottery stocks and other gambles. We demonstratethis theoretically and then show empirically, using a unique database of account datafrom a Chinese retail brokerage, that the realized losses of margin traders are oftensubstantial. This leads us to question whether current regulation is appropriate.