Investors are shying away from margin debt. Why that may not be a good thing.

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Investors pulled back from taking on more debt to buy stocks recently, signaling their reduced appetite for risk.

Margin debt, or the amount borrowed to purchase securities, dropped 2.45 percent in December, according to NYSE Euronext data released last week. The monthly decrease of $11.5 billion was also the largest since September last year. The NYSE figures represent the margin accounts of member firms.

Investors use margin to buy stocks on credit, and currently the Federal Reserve's Regulation T allows investors to borrow up to 50 percent of the price of securities purchased on margin. The Fed has not changed the margin requirements since 1974.

"Investors love going on margin in a rising market environment, but when the market declines, it can be extremely painful," said Paul Hickey, co-founder of Bespoke Investment Group. "Don't forget that if you go on margin you also have to pay interest on that loan, and some brokers charge pretty high rates, so you are already starting in the hole."

The margin debt indicator piques the interest of market professionals, because its surge and decline generally coincides with peaks and troughs in stocks.

For instance, the debt levels peaked at $278 billion back in March 2000; in the same month the S&P 500 Index first hit the high of 1,550. Prior to the financial crisis, debt margin peaked at $381 billion in July 2007, three months before the S&P 500 hit an all-time high.

Post-crisis, the Fed's highly accommodating monetary policy, which included quantitative easing, spurred investors to take on even more debt than before — pushing margin levels to record highs. Last April, that debt reached $507 billion (a month later S&P 500 hit an all-time) before dropping 9 percent to its current level of $461 billion.

Although declining margin levels are often cited as a bearish signal for the market, Hickey believes that it is a small concern given the indicator's coincidental nature. On the other hand, the prospect of rising rates spooks investors much more, and holds them back from buying stocks.

"Margin debt rises when the market rises and falls when the market falls," Hickey said. "If you look at the S&P 500's average returns after periods when margin debt falls 10 percent from a record high, the forward returns aren't much different than the overall returns for all periods."

"I think anxiety about rising rates plays a role, not only in the higher rates themselves, but concerns that higher rates will further slow economic growth which negatively impacts stocks," he added.

That said, others think margin debt can best be utilized as a proxy for further weakness during selloffs rather than timing of turning points.

"Although the NYSE margin debt data comes with a 2-month lag, its ongoing deterioration reflects a worrying feedback loop between falling equities and cascading margin balances, which is increasingly amplified by forced selling and redemption as clients respond to heightened momentum selling," said Ashraf Laidi, CEO of Intermarket Strategy.

Given similar trading patterns of the last several years, "we are left with the conclusion that this[selloff] risks being at least as bad as some of the deeper sell-offs seen in recent years," he said. "There is no relief buying from emerging markets and Middle East sovereign wealth funds."

The effects of that weakening market may already be evident.

The Russell 2000 and Nasdaq, which are homes to riskier small-caps and high-flying momentum names, are both down over 12 percent this year. This compares to the S&P 500 and large-cap Dow Jones Industrials — both down in single digits.

Could decreasing margin debt and money flowing from former high-flyers and riskier small caps indicate a potential slowdown ahead? That is a likely scenario, given that gains this year in defensive utilities and telecommunications — where investors frequently park cash during times of market stress — further confirms that traders are taking risk off the table for now.