Retail investors lured by new margin framework

But potentially dangerous unintended consequences lurk

Working through this month’s commentaries, the same word kept coming up: volatility. Now generally speaking, that’s been in reference to oil, inflation, rates...the standard. But I recently came across an article in Barron’s that introduced us to a new name on the list of volatility drivers, and this kind comes from someone (or a lot of someones) with $2,000 and a trading app.

As we find ourselves in the summer months, markets have not obliged the well-respected summer slowdown, instead greeting us with wave upon wave of volatility. Today’s environment is characterized by a significant and widening bifurcation. Mix in an energy supply shock, re-accelerating inflation, the continued question on AI spending sustainability, and “higher-for-longer” monetary policy regimes, let’s just say it’s mayhem in the marketplace. All the usual suspects, essentially. But there’s a newer force at work too, one based on individual stocks rather than the broader macro picture.

Let’s start with a stat: In June, margin debt hit a record high of $1.5 trillion, up 49% from a year ago, according to the Financial Industry Regulatory Authority.

How about another: Average volatility across a basket of 20 popular retail stocks has increased by 80%, relative to the same period last year. Even in tickers where institutions own a vast majority of the outstanding shares, small, we are seeing retail traders with the ability to create major swings in price action.

So, what’s going on? A dot-com era rule that previously restricted margin access for high-frequency traders to those with account balances of $25,000 or more has gotten a revamp. In June, a new margin framework replaced the 25-year-old pattern day-trader rule. Under the new intraday margin rule, retail traders can now execute unlimited day trades on margin with account balances as low as $2,000, granting smaller, less capitalized accounts far greater access to leverage.

Webull CEO Anthony Denier said during the company’s first-quarter earnings call in May that he expects the elimination of the pattern day trader rule to eventually boost trading volume by at least 20%.

The dark side

Although the new rules were met with excitement from retail investors, not all is well on the home front. When a trade goes wrong or markets turn quickly, traders operating with only a few thousand dollars in their accounts have fewer resources to meet margin calls, increasing the risk of forced selling during market declines. That vulnerability is growing as volatility rises across many heavily traded retail stocks, where sharp price moves make margin calls more likely. Even in a zero-commission environment, smaller, less experienced traders lose money due to a variety of factors, overconfidence in their information and abilities, volatility, and the reality that other market participants are better equipped to seize profitable trades and liquidity in seconds.

Not to mention the impact of everyone’s favorite Reddit forum, WallStreetBets. Stocks including Micron Technology, Sandisk, and AST SpaceMobile, all popular among retail traders on forums like WSB, have experienced sizable increases in volatility over recent weeks. Look back at what happened in prior years to stocks like GameStop, or even closer to home, BlackBerry. With these new leveraged opportunities in place, the future doesn’t necessarily look that friendly.

South Korea sets a (bad) example

If you want a preview of where unchecked retail leverage can lead, look no further than South Korea. The intense volatility rocking their chip-heavy stock market has come to America too, but so far Wall Street has only suffered modest losses by comparison. The question is whether this is just noise, or whether the semiconductor slump and vulnerability among highly leveraged investors eventually catch up to additional markets as well.

Regulators in Seoul have ramped up efforts to curb wild swings in equity prices, fueled in part by heavily leveraged retail investors using ETFs. These investors were pulled in by the extraordinary AI boom, and many have been caught out by the rapid snapback. According to Goldman Sachs, more than 1.2 million leveraged retail trading accounts in South Korea triggered margin calls as of July 13, with an estimated 320,000-360,000 accounts fully liquidated. Goldman’s strategists reckon this means around one in 30 adults in the country, or 3.4% of the adult population, have received margin calls.

That could have a meaningful impact on Korea’s economy more widely, if many South Korean households are now sitting on losses, that could weigh on the country’s economy moving forward. Given rising retail participation in U.S. stocks, exposure to the AI theme, and the rising popularity of leveraged vehicles: Could Wall Street, and the broader economy, be next?

The market just handed smaller traders a bigger lever to pull, right as tariffs and geopolitical risk start stacking up on the macro side. If this is what volatility looks like on a quiet news day, what happens on a loud one?

Laura Baker is Associate Client Portfolio Manager, Equities at PenderFund Capital Management. She writes in Pender Pulse Substack. Used with permission.

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