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There's No Mercy in Margin Calls

The trader saw it all day Monday. Hope doesn't factor into the margin clerk's equation.
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When margin selling strikes, it does so swiftly and brutally. You get two bad days and by the end of that second day the clerks are out in full force, selling out clients who were, basically, kiting the system.

How does it work? Well, I've done it. And while I have written before about it, let's do a quick refresher for our many new readers.

My client, Ken, has just bought 10,000 shares of

NationalGiftWrap.com

. He did not put new capital in, he just borrowed against existing holdings in

National Gift Wrap

, which had moved up dramatically on an announcement that it was going to open a business-to-business paper exchange. National Gift Wrap was the collateral for NationalGiftWrap.com.

B2B suddenly went out of favor on Monday, and the collateral collapsed in value. That meant Ken had to send in some money to pay for NationalGiftWrap.com. His collateral wasn't worth enough to cover the purchase of the dot-com. I let Ken know at 10 a.m. that he has to wire the money in. Today. Or be sold out of his newest buy. He tells me it is on its way. At 2 p.m. I check the wire room. No monies received. My boss tells me that I have to liquidate Ken's NationalGiftWrap.com. We don't bargain with Ken.

I then sell his NationalGiftWrap.com.

Here are things I don't do:

1. Get an extension for more time. My firm doesn't want the inventory risk.

2. Hope the market rallies. There is no hope in the equations of the market clerk.

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Rough stuff. Throughout the late afternoon this process was repeated thousands upon thousands of times. Many many stocks got sold at prices that didn't matter to the margin clerks. They aren't sensitive to the price. Which is how you get that hideous selling that occurred between 3 p.m. and 4 p.m. Monday.

As margin buying in this market is huge and growing, there are plenty of people in Ken's position after a two-day decline. So there was plenty of selling.

Margin selling is a bit ephemeral and hard to game. If the market rallies today, people get bailed out. If the market goes down, the margin selling accelerates.

As I write, Europe is down badly, which could mean the selling will continue. I was thinking

Oracle

(ORCL) - Get Report

could stem the decline, but it is too early to tell.

Oh, by the way, in all of the time that I executed these liquidations,

not once

did anybody send the money in.

Sobering. It is why I always urge against margin. Because you never want your financial destiny to be in the hands of the margin clerk. He is a butcher first and foremost.

James J. Cramer is manager of a hedge fund and co-founder of TheStreet.com. At time of publication, his fund was long Oracle. His fund often buys and sells securities that are the subject of his columns, both before and after the columns are published, and the positions that his fund takes may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Cramer's writings provide insights into the dynamics of money management and are not a solicitation for transactions. While he cannot provide investment advice or recommendations, he invites you to comment on his column at

jjcletters@thestreet.com.