What happens when a margin call occurs? Insights into leveraged trading from the 2021 Wall Street storm

$20 Billion Disappeared in 2 Days: A True Reflection of Liquidation and Forced Selling

In March 2021, a hedge fund manager named Bill Hwang lost $20 billion in just 48 hours, a loss that shocked Wall Street. On the surface, it appeared to be a margin call event, but a deeper analysis reveals that the answer to what happens during a forced liquidation is far more complex than we imagine.

Bill Hwang was not an reckless gambler. His investment strategy was actually a carefully calculated leverage amplification—selecting promising publicly traded stocks and using margin to expand his positions. This approach had allowed him to grow his assets from $220 million to $20 billion in just 10 years, making him a significant player on Wall Street. But leverage is like a double-edged sword; when a black swan event hits the market, the inverse power of high-multiplier leverage can be magnified countless times.

How Margin Calls Work: Why Forced Liquidation Happens

To understand what happens during a margin call, first, we need to grasp the essence of the margin trading tool.

The logic of margin trading is simple—believe a stock will rise, but with limited funds, you borrow money from your broker to increase your purchase size. In the standard practice of the Taiwan stock market, investors typically put up 40%, and brokers lend 60%. For example, if Apple stock is $150 per share and you only have $50, the broker can lend you $100 to buy one share.

The benefit is obvious—if the stock rises to $160, after selling, repaying the broker’s $100 plus interest, you keep the remaining $59.5, which is a 19% profit, far exceeding the stock’s 6.7% increase.

But what about the risks? If the stock drops to $78, the broker faces an awkward situation: can the borrowed money be recovered? They will then require you to immediately top up your margin.

Maintenance Margin is the core indicator of this mechanism. When the initial stock price is $100, the maintenance margin is set at 167% (100 ÷ 60). When the maintenance margin falls below 130% (corresponding to a stock price of $78), the broker will initiate a “margin call,” demanding the investor to add funds. If you cannot meet the requirement within the specified time, the broker has the right to sell your stocks directly—this is forced liquidation, also known as margin call liquidation or 爆倉.

What Happens During Margin Call Liquidation: Chain Reactions in the Stock Market

If only a single investor is liquidated, it may not cause much turbulence. But when margin calls turn into a full-blown storm, the situation changes entirely.

Step 1: Accelerated Stock Price Decline

Retail investors tend to hesitate when stocks fall—should they cut losses and sell? But brokers have no such hesitation; their only goal is to recover the lent money. Their selling actions prioritize execution speed over price, often selling at any price. The result? Stocks are hammered well below their normal levels, triggering panic among other investors who also face margin calls, causing the stock price to plunge further.

Taking Bill Hwang’s case as an example, his holdings in Baidu and other tech stocks were forcibly liquidated. Due to his large position sizes, the market lacked sufficient buy-side volume to absorb the sell-offs, leading to direct price crashes.

Step 2: Breakdown of the Shareholding Structure

Under normal circumstances, a listed company’s shareholding structure consists of three groups: internal management (stable holdings), long-term institutional investors like pension funds and insurance companies (stable holdings), and retail and short-term traders (liquid holdings).

But after margin calls, stocks sold off by brokers flood into retail investors. Retail investors tend to be short-sighted, trading frequently on small price movements. The consequence? Large institutional investors see the shareholding structure being shattered and tend to avoid the stock, leading to a prolonged downtrend. Unless there is a significant positive catalyst, it becomes very difficult to attract large capital back in.

Step 3: Chain of Risks

In Bill Hwang’s case, the answer to what happens during margin call liquidation is even more complicated. After his stocks were forcibly sold, the collateral positions showed gaps. To cover these gaps, brokers had to liquidate all his holdings, including stocks that were performing well and had no downward pressure. This, in turn, dragged down even the stable stocks, causing his entire portfolio to plummet collectively within a short period.

How Margin Call Liquidation Affects Different Investors

Long Position Investors: Avoid stocks with liquidation risk

If you are a bullish investor, margin calls can be devastating. You might be forced to sell at prices far below fair value due to massive forced liquidations. Therefore, identifying stocks at risk of margin calls becomes crucial—stocks with lower liquidity and smaller market caps are generally riskier.

Short Sellers: Exploit opportunities for profit

Conversely, if you are bearish, margin call events can provide excellent profit opportunities. Large-scale forced liquidations often lead to oversold conditions, creating shorting opportunities.

How to Use Margin Effectively Without Getting Liquidated

Margin trading is not inherently dangerous; with proper management, it can help investors utilize capital more efficiently.

Strategy 1: Gradual Position Building

If you are optimistic about a company but have limited funds, margin can help you build positions gradually. When the stock rises, you enjoy gains; when it falls, you still have remaining funds to buy more and lower your average cost.

Strategy 2: Choose Highly Liquid Stocks

This is the most important lesson from Bill Hwang’s story. When trading on margin, always select stocks with large market caps and high liquidity. Otherwise, during a margin call, stocks may experience extreme volatility, and chain reactions could even involve you.

Strategy 3: Calculate Margin Costs

Margin involves paying interest. Some stocks have minimal long-term volatility, and their returns mainly come from dividends. If a stock’s annual dividend equals the margin interest, the investment loses its purpose. You must ensure the expected stock appreciation exceeds the margin interest to generate net profit.

Strategy 4: Use Technical Support and Resistance for Profit and Stop-Loss

Stocks often consolidate at resistance and support levels. When trading on margin, if the stock hits resistance but cannot break through, it may enter a prolonged consolidation, during which you keep paying interest. A wise approach is to take profits if the stock cannot break resistance. Conversely, if the stock breaks support, a short-term rebound is unlikely, and you should cut losses to avoid ongoing losses.

Conclusion: Discipline is Key

Leverage amplifies both gains and losses. The question of what happens during a margin call has no absolute answer; it depends on how you use the tool.

Disciplined investors use margin to improve capital efficiency, while undisciplined ones can be destroyed by margin calls. Bill Hwang’s fall from $20 billion to near bankruptcy teaches us that it’s not just leverage that’s dangerous, but the lack of risk management. Any leverage tool can become a ticking time bomb without proper controls.

Always do thorough research before investing, set clear stop-loss and take-profit points, and only then can you truly avoid the unknown risks of margin calls.