Wednesday, October 19, 2011

Forced Selling

What is Forced Selling?

Forced Selling is simply; where your broker, on his own will, sell stocks that belong to you. Yes, that's the process. But there's a story behind it. 

Forced Selling can only occur if you, the investor, buys stocks on broker credit. That means you decide to invest in stocks worth more than what you have actually invested in the stock market by yourself. The broker will usually provide a credit limit up to 50% of your total investment, but this can hugely vary form stock market to another. The next part is settlement of the credit. It's a very short term loan, so it must be paid back. Usually the brokers provide the investor around 3 days (T+3) to settle the credit, but some stock markets may extend this date up to T+5 (5 days). 

So when the settlement date arrives, the investor should have enough money or liquid cash in his portfolio to pay back the broker. The investor could either willingly sell all or portion of his portfolio sufficient to cover the credit or settle the credit with cash directly. But settling with cash seems unlikely since you're already trading on credit. We could opt. to sell our stocks and settle the credit, if the stocks had made us our intended profits. But if the stocks have crumbled, we wouldn't want to sell them. This is where Forced Selling comes. 

If the available credit isn't settled as of the time limit allowed, your broker will have all the powers to sell any portion of your portfolio up to an amount sufficient to cover the credit. This is called Forced Selling, as you are forced to sell your investments to settle the credit. This is a fully legal process and the investor cannot do anything to stop it or take any legal action against it. 

We can understand that this will mostly affect the traders rather than investors. Investors concentrate on the long term and the broker credit facilitates credit up to maximum 5 days only. So traders are the ones who usually get the worst out of this.

This is just another reason why most investment advisers ask the investors not to trade on credit. Unless you are 200% sure of what you're doing, my advice is, don't go for broker credits.    

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