Understanding Margin Calls
Let me explain what a margin call is: it's your broker demanding that you, as an investor who's borrowed money to buy securities, deposit more money or securities into your account to bring it up to a minimum value.
Essentially, a margin call is a request for funds from your broker when you need to add money to your margin account to meet the minimum capital requirements. This occurs when the percentage of your equity in the margin account falls below what the broker requires.
Your margin account holds securities purchased with a mix of your own money and funds borrowed from the broker. A margin call specifically means the broker is asking you to deposit additional money or securities so that your equity value and the overall account value reach the minimum set by the maintenance requirement.
Usually, a margin call signals that the securities in your margin account have dropped in value. When this happens, you have to decide whether to deposit more funds or marginable securities, or sell some assets in the account.
Key Takeaways on Margin Calls
You should know that a margin call happens when your margin account is low on funds, often from a losing trade. These calls demand additional capital or securities to get the account back to the maintenance requirement.
If you don't deposit funds, brokers can force you to sell assets at whatever market price is available to meet the call. Margin calls aren't limited to falling stocks; they can also hit if a stock rises and you're short-selling it.
To steer clear of margin calls, keep an eye on your equity and maintain enough funds in the account to stay above the required maintenance level.
What Triggers a Margin Call?
You're buying on margin when you use a combination of your own funds and borrowed money from a broker to purchase securities. Your equity in that investment is the market value of the securities minus what you've borrowed.
A margin call gets triggered when your equity, as a percentage of the total market value of the securities, drops below the maintenance margin level required by the broker.
The NYSE and FINRA require at least 25% equity for margin buying, but some brokers set it higher, like 50%—that's up to them. These calls can happen anytime the account value drops, but they're more common during market volatility.
Example of a Margin Call
Let me walk you through an example where a drop in value triggers a margin call. Suppose you buy a security for $20,000, half on margin, so your equity is $10,000 or 50%. If the value drops to $14,000, your equity becomes $4,000 or about 28%.
If the broker's maintenance requirement is 30%, that's $4,200 needed for the $14,000 value, so you'd get a margin call for $200 to make up the difference.
How to Cover a Margin Call
If your account drops and triggers a margin call, you typically have two to five days to act. Using the example above, you could deposit $200 in cash, or deposit $285 worth of fully paid marginable securities—calculated as $200 divided by (1 - 0.30).
You could also combine those options or sell other securities to get the cash. If you don't act, the broker might close out positions without your approval, charge commissions, and hold you responsible for any losses.
Remember, the margin loan amount is fixed based on the purchase price, but the maintenance requirement fluctuates with the current account value.
How to Avoid a Margin Call
Before opening a margin account, think hard about whether you need one—most long-term investors do fine without borrowing, and these loans come with interest charges.
If you do use margin, keep cash ready in an interest-earning account at the same brokerage. Build a diversified portfolio to limit the impact of any single position dropping.
Monitor your positions, equity, and loans daily. Set alerts above the maintenance requirement, and if you hit that level, deposit funds or securities right away. Handle any margin call immediately.
Use protective stop orders to limit losses, and always keep adequate cash and securities in the account.
Risks and Management of Margin Trading
Trading stocks on margin is riskier than without it, since you're using borrowed money, which amplifies losses—you could lose more than you invested.
To meet a margin call, deposit cash or securities or liquidate holdings; you can't delay, as brokers can liquidate without notice. Manage risks with stop-loss orders, keep leverage low, and borrow against a diversified portfolio to reduce call chances.
High overall margin debt can increase market volatility, as forced sales during declines create a cycle of more selling and lower prices.
The Bottom Line
Buying on margin isn't for every investor, especially if you lack funds for initial and maintenance margins. It can amplify gains, but only if securities rise enough to cover the loan and interest.
The downsides include margin calls that might force you to deposit more or sell at a loss, often during volatile markets when prices are low.
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