In a previous article, we have made it clear or at least tried to make it clear that for Chinese assets at least, riding trading positions until liquidation is not exactly the wisest of approaches. Before continuing with this post, we would strongly recommend reading the article in question by clicking HERE and, in a nutshell, it revolves around us explaining that setting (more or less aggressive) stop-loss orders tends to be the superior strategy.
In other words, while we do understand that your trading model might revolve around trying to avoid instances in which you are knocked out of position by short-term market movements against you (movements you consider noise), there is no reason to ride your position all the way down to liquidation so as to achieve a goal that can be reached through… well, simply setting more aggressive stop-loss orders.
Let us assume that no, you do not agree with our way of thinking and choose to ride Chinese asset trading positions until liquidations. Should that be the case, you will ultimately have to deal with yet another question before you get to the liquidation point: should you add mode margin (fund your brokerage account with more capital, in other words) so as to try to “save” your position by lowering the liquidation point or should you simply stay put? Most brokers will let you know when it’s time to make such a decision through a so-called margin call, and you will need to figure out what the best course of action is.
Can adding margin sometimes prove to be an approach that “saves” your position?
It isn’t the least bit difficult to imagine scenarios which involve the price going to let’s say just 1% below your liquidation point before recovering and as such, adding enough extra margin so as to lower your liquidation point to let’s say 2-3% below the current value would have been enough to save the position and enable you to ride the recovery.
However, this doesn’t mean adding extra margin is the wise thing to do.
On the contrary, more often than not, it… well, isn’t.
It ultimately all depends on WHY you are making the decision to add extra margin. As explained in our article about whether or not it makes sense to ride positions until liquidation, there is a very fine/blurry line between trading and gambling. And just like compulsive gamblers “double down” in a desperate effort to break even after losing money, compulsive traders can be guilty of the exact same behavior: not understanding/accepting the fact that the trade in question represented a mistake and continuously adding margin to what might become a “black hole” losing position.
As always, the name of the game is being brutally honest enough with yourself so as to answer one simple question: are you adding margin for emotional or genuinely rational reasons? To put it differently, are you adding margin to your position because you do not want to lose money due to how much you have invested (the sunk cost fallacy) or due to the fact that you do not want to accept that you made a mistake (emotional attachment to a position)? If that is the case, please do not make the mistake of going through with your plan.
However, it would be short-sighted not to acknowledge the fact that there are indeed instances in which adding margin is the rational thing to do. For example, if you have valid reasons to believe that the market got carried away when it comes to a crash and that in the long(er) run, this will be nothing more than a wick on higher time frames (daily, weekly and monthly charts rather than hourly charts), then yes: adding margin can be a calculated decision.
But, of course, be sure to always think multiple steps ahead in such cases. Or, to put it differently, let us assume you are indeed correct that the market got too frightened and prices end up recovering: do you hang on to your position indefinitely or has this crash altered your underlying hypothesis? In some cases, price action may indeed be overly-aggressive on a temporary basis and while you were correct that the market corrected too much too soon, the price action in question might also contain answers which invalidate the underlying hypothesis on which your initial trade is based. As such, in that particular instance, adding margin might have been the correct approach but it would be wise to look for an exit scenario sooner rather than later, even if it would involve losses (in other words, adding margin will have helped you avoid too steep of a loss but nonetheless, closing the position at a loss would be the right call).
As can be seen, “nuance” is the operative word when it comes to trading Chinese assets and pretty much any other asset class. For the most part, having to decide whether or not adding margin to a trade is the way to go is let’s say a rather unusual position to find yourself in. Those who trade ultra-volatile assets such as cryptocurrencies most likely end up in such situations more frequently than those who trade Chinese assets and the same way, those who trade Chinese assets end up in such situations more frequently than those who trade even less volatile assets such as US Treasuries… unless, of course, the trader is recklessly over-leveraged in the latter scenario.
Should you add margin if/when margin called? In some instances, this makes sense but be sure to only embark on this journey if your model indicates that this is the rational thing to do. In most cases, adding margin ends up putting the trader in gambling territory and that is a situation we would recommend avoiding at all costs. For a more in-depth as well as personalized approach centered around the trading-related needs of you and/or your organization, the ChinaFund.com team of consultants is only a message away.