How does financing loss occur? From the liquidation mechanism to Bill Hwang's blood and tears lessons

When mentioning the most shocking investment crash on Wall Street in 2021, many people immediately think of Bill Hwang. This hedge fund manager lost $20 billion in just two days, becoming one of the fastest losers in recent years. His story is not due to bad luck but serves as an ultimate warning about uncontrolled leverage.

In-Depth Interpretation of Margin Calls: Why Borrowing to Invest Can Lead to Forced Liquidation

A margin call, simply put, is when you invest in stocks using borrowed money, and the stock price falls below expectations. To protect their loans, the brokerage firm will directly force-sell your stocks. It sounds cold, but this is the market’s self-protection mechanism.

First, let’s understand how margin works. Suppose you believe a stock will rise, but your cash is limited. You can apply for margin financing: you put up a portion of the funds (e.g., 40%), and the broker loans you the remaining (60%). This way, you can leverage a smaller amount of capital to control a larger position.

Using specific numbers makes it clearer. Suppose Apple stock is currently $150 per share, and you only have $50. Through margin, the broker loans you $100, allowing you to buy 1 share. If the stock rises to $160, you sell, repay the broker $100 plus interest, and make a profit of about 19%—much higher than the stock’s own 6.7% increase, showcasing leverage’s power.

But the opposite can be equally intense. If Apple drops to $78, your situation immediately turns into a nightmare. In the Taiwan stock market, the margin maintenance requirement is not lower than 130%. When the stock price falls, this ratio deteriorates rapidly. Initially, at a $100 stock price, the maintenance ratio is 167%, but when it drops to $78, it falls below the 130% warning line. The broker will send a margin call notice, demanding you to immediately top up your margin.

If you lack sufficient cash to do so, the broker won’t wait—they will directly sell your stocks in the market for cash—this is forced liquidation. From an investor’s perspective, this process is called a margin call or liquidation. Once called, you not only suffer losses but also incur additional costs due to rapid exit at the current market price.

Chain Reaction of Margin Calls and Liquidations: Why One Person’s Liquidation Can Trigger a Market Storm

Bill Hwang’s story is a textbook example illustrating the systemic impact of margin calls.

Hwang was a leverage expert. Over ten years, he grew $220 million into $20 billion by continuously using high leverage, selecting promising companies, and heavily weighting his positions. Such a strategy can generate astronomical returns in a bull market, but once the market turns, the risks are equally astronomical.

In 2021, as market volatility increased, his holdings began to fluctuate. To prevent their own exposure, brokers decided to forcibly liquidate some of his stocks to maintain margin levels. But Hwang held a huge amount of stocks, and when he started to sell large quantities, the market lacked enough buy-side volume to absorb the sell-off. This caused stock prices to plummet, further triggering margin calls from other investors, creating a chain reaction.

Adding to the chaos, to maintain overall margin ratios, brokers even started to liquidate stocks in his portfolio that were performing well. This indiscriminate forced selling further fueled market panic, and all his stocks experienced sharp declines within just two days.

Direct Impact of Margin Calls and Liquidation on Stock Prices

Accelerant of Stock Price Out-of-Control Drop

When retail investors see stock prices fall, most hesitate whether to cut losses and sell. But brokers think very differently—they only care about recovering the lent principal. When executing forced liquidation, they usually prioritize execution speed over better prices for investors.

This means that when a stock crashes due to a margin call, its price often overshoots to extremely low levels. Such irrational lows tend to trigger the next wave of margin calls, causing a spiral downward. If you are a long investor, you should avoid stocks with signs of a margin call risk; conversely, short sellers can profit from such storms.

Deterioration of Chips and Subsequent Market Risks

Under normal circumstances, internal management teams and long-term institutional investors (retirement funds, insurance companies, etc.) are considered stable chips—they hold stocks for a long time with confidence. But once a large-scale margin call occurs, the stocks sold by brokers flow into the hands of retail investors.

Retail investors are prone to short-term fluctuations; any market movement can trigger buying or selling. This causes long-term capital to exit, and large funds become even less willing to enter to absorb the stocks. As a result, stocks continue to decline until major positive news can attract new capital. Therefore, stocks after a margin call are generally not recommended for investment, as the short-term downside risk remains high.

Five Rules to Use Margin Effectively Without Falling Victim to It

Although margin risks are significant, savvy investors can greatly enhance their capital efficiency through proper use.

First, use margin to stagger your positions. Suppose you are optimistic about a company but have limited funds. Margin allows you to buy in stages at different prices, keeping cash available to respond to further declines. If the stock rises, you enjoy gains; if it falls, you can add more to lower your average cost.

Second, only use margin on stocks with high liquidity. Bill Hwang’s lesson is that holding too large a position can make it impossible to sell without causing a big price drop. Always choose stocks with sufficient market capitalization and daily trading volume, so even in an emergency exit, slippage is minimized.

Third, calculate the ratio of margin costs to expected returns. Margin involves paying interest to the broker. If the annual dividend yield of your stock is similar to the annual interest rate of the margin loan, then margin use becomes meaningless—your returns are eaten up by interest.

Fourth, set clear exit points at technical resistance and support levels. Stocks often consolidate around resistance and support zones. If using margin, and the stock hits resistance but cannot break through, it may stay in a range for a long time, costing you interest without price appreciation. It’s advisable to take profits if it fails to break resistance. Conversely, if the stock breaks support, a short-term rebound is unlikely, and a stop-loss should be executed immediately.

Fifth, discipline above all. Planned entries and exits, definite take-profit and stop-loss points, and clear position control are keys to long-term success. Margin amplifies both gains and losses; only disciplined traders can tame it.

The Ultimate Revelation of the Meaning of Margin Calls

Margin is a double-edged sword. Proper use can accelerate wealth accumulation, but misuse can quickly wipe out assets. Bill Hwang’s story of falling from $20 billion to zero, and the margin call waves during market fluctuations, all remind investors of a universal truth:

High leverage yields high returns, but black swans never give advance notice. Margin calls are not distant events—they are a normal market mechanism. Doing thorough research before investing, choosing the right assets, and setting reasonable leverage ratios are essential to pursue gains while keeping risks within manageable limits.