You’ve probably heard of the term margin call many times, especially if you’ve been following the stock market or if you’re involved in trading. Perhaps you even know what it is but don’t fully understand how or why it happens.
On that note, we created a short guide explaining what a margin call is, how it works, and what you can do to avoid one.
What Is a Margin Call?
In the world of investing, buying on margin means you’re able to invest in more securities than you could with just your available cash by taking out a loan from your brokerage.
A margin call occurs when the balance on your brokerage account drops below a certain level. When a margin call is issued, the broker demands that an investor puts more money or securities into their account as collateral to meet the margin.
While investors may benefit from margin buying if the value of their investments surpasses the cost of the loan, they can also lose money more quickly. This is why, in most situations, margin investing should be left to professionals.
Margin Call Example
Let’s assume you want to put $10,000 into your account and you want your broker to lend you an additional $10,000. The borrowed sum is called the margin.
Now, let’s say you want to invest these $20,000 in 200 shares for $100 a share. By doing so, you’ll end up with a maintenance margin of 30%.
That said, if the market value of your account drops below $14,285.71 and the stock price of the company you invested in drops to $71.42 or less, you’ll most likely receive a margin call.
To avoid this scenario, you can make the following margin call calculation:
- Deposit $1,600 into your account.
- Transfer $1,600 of marginable securities to your account.
- Make a combination of the above options.
- Sell $3,333.33 worth of company stock to raise your account equity to the 30% threshold.
Remember that these are just the bare minimum requirements to bring you up to the maintenance margin. If the stock price keeps dropping, you’ll need to add more equity.
Common Triggers
When do margin calls happen? They can happen anytime, but they are more common in periods of extreme market volatility.
What triggers a margin call is when your equity falls below the required level, expressed as a percentage of the total market value of securities. This is known as the maintenance margin.
The minimum margin that investors are required to have varies by firm. For example, when buying on margin, the NYSE and the FINRA demand that investors keep an equity ratio of 25% of the overall value of their securities.
However, some brokerages demand a higher maintenance margin, which can reach 30%–40%.
What Is a Margin Account?
A brokerage account where investors can borrow money from their brokers, such as Robinhood or Fidelity, is called a margin account. This allows investors to buy securities using their account as collateral.
However, utilizing a margin account as part of your investing plan entails taking on debt and additional risk.
Namely, margin loans come with interest, and if the market value of securities purchased with a margin account drops, you will have to repay the loan immediately.
How do margin accounts work? Margin accounts are subject to a few regulations set by the SEC, FINRA, and other organizations. These include the following:
- Minimum margin. You can start trading on margin after you’ve met the minimum margin requirement. The minimum deposit required by FINRA for margin trading is $2,000 in cash or 100% of the stock’s purchase price.
- Initial margin. You can usually only finance 50% of the cost of the securities you want to purchase. For example, if you have $3,000 in your margin account, you could buy $6,000 of stock on margin.
- Maintenance margin. You must own at least 25% of the assets in your margin account.
However, your brokerage can always set higher margin requirements if they choose to.
What Is the Margin Call Price?
The margin call price is the minimum percentage of equity that must be maintained in a margin account before triggering a margin call.
To calculate a margin call price, you can use the following formula:
Initial Purchase Price x [(1 – Initial Margin) /(1 – Maintenance Margin)]
Let’s make things more clear with a margin call formula example.
Let’s assume you opened a margin account and put $60,000 of your own money in it. If you borrow $60,000 at a 50% margin, you’ll be able to spend a total of $120,000 on securities.
In this scenario, the formula would look like this:
$120,000 (initial purchase price) x [(1 – 50% (initial margin)) / (1 – 25% (maintenance margin))] = $80,000.
So, if your account value falls below $80,000, you may be subject to a margin call.
Now that you know all about calculating a margin call, let’s see what you can do to avoid it.
How to Avoid a Margin Call
There are a few things you can do to avoid a margin call:
- Monitor your account balance and make sure you have enough equity to meet the maintenance margin requirements.
- Diversify your investments, so you’re not putting all your eggs in one basket.
- Keep some extra money in your account. This will give you a buffer if you ever get a margin call.
- Set your own minimum maintenance margin above the minimum allowed by your broker. If your account reaches that number, transfer your money to prevent a margin call.
Can I Delay Meeting a Margin Call?
A margin call is an urgent request for additional funds and must be met promptly. However, you can sometimes delay meeting a margin call for up to five days if your broker agrees.
What time do margin calls go out? Brokerages generally contact investors before trading opens the morning/day after the equity in their account falls below the minimum requirement.
At the same time, brokerages can also issue a margin call in real time, and they may do so during times of high volatility.
What Happens if I Fail to Meet a Margin Call?
If you fail to meet a margin call, your broker may liquidate any open positions to restore the account to its minimum value. This is referred to as a liquidation or forced sale. Your broker may make these changes without your consent.
Furthermore, there’s a chance you’ll be charged a fee for the transaction and any interest owing on the original loan.
Conclusion
Now that you know what’s behind the margin call definition, what triggers it, and what happens if you don’t meet one, you’re in a much better position to protect your investments.
Remember to always monitor your account balance, set your own minimum maintenance margin, and keep some extra cash on hand in case of emergencies.
On the other hand, if you happen to receive a margin call, try to take measures to avoid liquidation by meeting the call promptly.
FAQs
What happens if you get a margin call?
If you get a margin call, you’ll need to add more money to your account or sell some of your securities. This is because the value of your account has fallen below the minimum required amount.
If you don’t take action to meet the margin call, your broker may sell some of your securities or close your positions.
Do you have to pay a margin call?
No, you don’t have to pay a margin call. However, failing to do so could result in your broker liquidating your position to restore the account to its minimum value.
Additionally, you may be required to pay a fee for the transaction and any interest that has accrued on the original loan. Therefore, it’s generally in your best interest to pay a margin call immediately.
What is a margin call in crypto?
A margin call in crypto is when a trading platform requests that an account holder deposit more funds to cover potential losses.
If the margin drops below a determined level, the platform will close your position, meaning you will lose your deposit. The platform will also sell a trade to minimize any money lost beyond your starting margin.
What is meant by a margin call?
A margin call is when your broker requests more collateral if the value of your securities in your margin account falls below a certain level, known as the maintenance margin.
If you don’t meet the demand, your broker can sell some or all of the securities in your account to cover the shortfall.
Margin calls can happen at any time and are especially common during periods of market volatility.
The answer to “What is a margin call?” is fairly simple, but let’s hope you won’t be in a position to experience it.
