Investment decisions are primarily driven by several fundamental considerations, including expected returns, risk, risk tolerance, and psychological factors, particularly the psychological mechanisms underlying rational and irrational trading decisions. Under a rational decision-making framework, investors seek to optimize their expected returns while assuming a level of risk that is consistent with their individual risk tolerance. Nevertheless, as market conditions evolve, investors may become subject to various cognitive biases that distort their judgment, thereby leading to irrational or erroneous investment decisions. In some cases, investors may become excessively focused on the pursuit of returns while neglecting the associated risks and their own capacity to absorb potential losses.
For example, the stock market has remained in a pronounced bull-market environment in recent years, characterized by persistent upward momentum and relatively limited corrections. This trend has been particularly evident amid the rapid expansion of the artificial intelligence (AI) sector, which has contributed to repeated record highs in equity markets. Since the beginning of this year, the Taiwan Stock Exchange Capitalization Weighted Stock Index (TAIEX) has increased by approximately 50%, while the total market capitalization of Taiwan's stock market has surpassed NT$150 trillion. Measured from the market low following the reciprocal tariff announcement by U.S. President Donald Trump in April of last year, the TAIEX has risen by approximately 1.5 times. This unprecedented rally has generated exceptionally strong investor enthusiasm and, in some cases, has fostered excessive confidence among market participants. Some investors have consequently increased their equity exposures through margin financing and other forms of borrowing, with the expectation that financial leverage would enable them to achieve substantially higher returns.
As stock price indices have continued to rise, margin financing balances—which tend to move positively with market prices—have likewise reached successive record highs this year. At the end of June, the balance of margin purchases in the TWSE-listed market reached approximately NT$611.6 billion, while the aggregate balance of margin purchases for securities listed on both the TWSE and the Taipei Exchange reached approximately NT$818.7 billion. These figures indicate that leverage trading activity has been exceptionally vigorous. At the same time, however, the widespread use of margin financing has, often imperceptibly, increased investors' exposure to both financial leverage and market risk. Under Taiwan's regulatory framework, margin purchases entail the provision of investor funds and the use of securities purchased on margin as collateral, while changes in collateral value may trigger additional margin requirements and, in the event of failure to meet such requirements, the disposal of collateral.
More recently, the risk of corrections in major global equity indices has increased. Given the relatively high degree of co-movement between the Taiwanese stock market and international equity markets, together with the comparatively substantial magnitude of price fluctuations in Taiwan equities, market participants have increasingly focused on the leverage risks associated with margin transactions. At the same time, concerns have emerged that a potential wave of forced liquidations among margin investors could amplify downward pressure and adversely affect the subsequent trajectory of the Taiwanese stock market.
Participants in margin trading have traditionally consisted predominantly of individual investors, many of whom conduct transactions with relatively limited amounts of personal capital. Compared with institutional investors and other large-scale market participants, retail investors generally possess a more limited capacity to withstand adverse market movements and absorb investment losses. Accordingly, a fundamental principle of prudent investment is that margin investors should carefully assess their own financial circumstances, employ leverage instruments only to an appropriate extent, and be fully aware of the potential consequences of market volatility. In this regard, maintaining leverage at a level commensurate with one's financial capacity and risk tolerance should be regarded as an essential discipline in margin trading.
Under the current margin trading framework, investors are required to provide 40% of the funds from their own capital, while securities firms provide the remaining 60% through margin financing. In other words, margin financing enables investors to leverage the capital originally required to purchase one unit of a stock into an equity position equivalent to approximately 2.5 units. Accordingly, both potential returns and potential losses are magnified. For each margin-financed transaction, investors are required to provide collateral at a prescribed ratio. Under the current regulatory framework, the initial margin maintenance ratio is approximately 166%. This mechanism is primarily designed to provide a certain degree of financial buffer through collateralization, thereby mitigating the risk of credit default.
When an investor's collateral maintenance ratio falls below 130%, the investor is required to deposit additional collateral in accordance with the applicable regulations. If the required collateral is not replenished within the prescribed period—within two days from the date on which the notice is duly served—the securities firm may dispose of the collateral in accordance with the relevant regulations. In general, during the period between the issuance of a margin call and the actual disposal of collateral, the margin would ordinarily remain higher than 100% even when the market is volatile. Accordingly, the proceeds generated from the disposal of such collateral should, in principle, be sufficient to repay the outstanding margin loan, thereby reducing the likelihood of credit losses being incurred by the securities firm.
According to data released by the authority in July, the overall collateral maintenance ratio was approximately 175%, remaining at a relatively high and stable level. Nevertheless, if market prices undergo a prolonged and substantial correction while investors lack sufficient additional capital to meet margin calls, the forced disposal of collateral may ultimately leave little or no residual value available for return to the investor. Consequently, the investor's original equity contribution may be substantially, or even entirely, depleted. It has also been observed that some investors may obtain investment capital through collateralized borrowing from other financial institutions, automobile loans, mortgage refinancing or additional mortgage borrowing, personal credit loans, or other forms of debt financing before deploying such funds in the equity market. Under such circumstances, once forced liquidation occurs, investors may not only absorb the losses associated with their original investments but also continue to meet their repayment obligations under these other loans, causing the issue of solvency. If the resulting deterioration in cash flow materially impairs their debt-servicing capacity, their overall financial risk may deteriorate further, creating a potentially adverse feedback loop between investment losses, liquidity constraints, and debt-servicing pressure.
Suppose that both the proportion and aggregate scale of leveraged investment increase across the market. During a period of rapid equity-market declines, the demand for collateral liquidation may intensify simultaneously, potentially giving rise to liquidity shortages or an excessive concentration of selling pressure. Under such circumstances, the realized prices of collateralized securities may fall below expectations. If leveraged investors broadly encounter similar financial constraints, or simply no longer capable of repaying, both credit risk and liquidity pressures may increase substantially, thereby raising the probability of loan defaults. Such developments would pose an additional challenge to the stability of the equity market and could, in turn, generate further downward pressure on market prices.
The credit trading system itself has established a risk-management framework through collateral requirements and collateral maintenance ratios, and the overall collateral maintenance ratio currently remains at a relatively sound level. Nevertheless, leverage can be a double-edged sword. When investors employ margin financing or other forms of borrowed capital for investment purposes, they should therefore give full consideration to the potential financial consequences of market volatility and carefully assess both their debt-servicing capacity and risk tolerance. From the perspective of rational investment, leverage should not be viewed merely as a means of amplifying expected returns, but rather as a mechanism that simultaneously magnifies downside risk. Prudent investors should accordingly ensure that the scale of leverage employed remains commensurate with their financial capacity and risk-bearing ability, thereby mitigating the potential risks arising from leveraged investment.