What Is a Margin Call?
A margin requirement arises when the percentage of the investor’s own funds in the margin account falls below the amount required by the broker. The investor’s margin account contains securities purchased at the expense of the investor’s own funds and funds borrowed from the investor’s broker.
A margin requirement is a broker’s requirement for an investor to deposit additional money or securities into the account so that the value of the investor’s equity (and the value of the account) increases to the minimum value specified in the service requirement.
A margin call is usually an indicator that securities held in a margin account have declined in price. If a margin requirement arises, the investor must either deposit additional funds or margin securities into the account, or sell part of the assets held in his account.
How to avoid a Margin Call?
The easiest way to avoid a margin situation is to not have a margin account at all. If you are not a professional trader, buying securities with margin is not a prerequisite for obtaining a decent income for a long time. But if you do have a margin account, here are a few ways to avoid a margin call.
- Have additional funds available. The availability of additional funds that can be deposited into the account should help you in the event of a margin call. Depositing additional funds is one way to ensure compliance with margin requirements.
- Diversification to limit volatility. Diversification should help limit the likelihood of an extreme drop, which can quickly trigger a margin call. Conversely, excessive concentration on volatile assets can make you vulnerable to sharp drops, which can lead to a margin call.
- Carefully monitor the status of your account. While it’s best for most people not to look at their portfolio every day, if you have a significant margin balance, you should monitor it daily. This will help you to be aware of the condition of your portfolio and whether it is approaching the level of the supporting margin.
What Triggers a Margin Call?
If the investor pays for the purchase and sale of significant securities using a combination of personal money and funds acquired in debt with a broker, the investor makes a margin purchase. The investor’s personal principal capital in the investment is equal to the market price of the relevant securities minus the amount assigned to the debt1.
Margin condition appears, if the investor’s personal fixed capital in a profitable relationship to the single bazaar price of significant securities goes down further than a specific necessary degree (thus called the reference margin).
The New York Stock Market (NYSE) as well as the Financial Industry Regulatory Authority (FINRA) – the regulatory apparatus of many firms working together with securities in the United States of America – call for the presence of margin purchases traders to maintain the degree of their funds in the amount of 25% of the single price of securities.23 Certain brokerage firms call for the most significant degree of margin, in some cases up to 30%-40%.
Margin conditions have all chances to appear in every period in connection with the fall of the price. But more generally they are made in the stages of volatility of trading.
How to Cover a Margin Call?
If the value of the investor’s account falls to the level at which the broker issues a margin call, the investor usually has two to five days to complete it. Using the example of the margin call given above, the following options can be considered:
- Deposit $200 in cash to the account.
- Deposit $285 of margin securities (fully paid) to the account. This amount is obtained by dividing the required funds in the amount of $200 by (1 minus the equity requirement of 30%): 200/ (1-.30) = $285.
- Use a combination of the above two options.
- Sell other securities to obtain the necessary funds.
If the investor cannot fulfill the margin requirement, the broker can close all open positions in order to replenish the account to the minimum required value. The broker can do this without the consent of the investor. In addition, the broker may charge the investor a commission for this operation (operations). The investor is responsible for any losses incurred during this process.
Margin call example: How to calculate
Let’s say you put $10,000 into your account and took another $10,000 from the broker on margin. You decided to take your $20,000 and invest it in 200 shares of XYZ company, trading at $100 per share. Your service margin is 30%.
Is it risky to trade stocks with Margin?
Trading stocks with margin is certainly riskier than without it. This is due to the fact that margin trading in stocks is trading with borrowed money. Leveraged transactions are riskier than non-leveraged transactions. The biggest risk in margin trading is that the investor may lose more than he has invested.
How can I fulfill the Margin requirement?
A margin call is placed by the broker when there is a margin deficit on the trader’s margin account. To eliminate the margin deficit, the trader must either deposit funds or margin securities into the margin account, or liquidate some of the securities in the margin account.
Can a trader postpone fulfilling a Margin requirement?
The margin requirement must be met immediately and without any delay. Although some brokers may give you two to five days to fulfill the margin deposit requirement, the standard margin account agreement usually states in small print that in order to fulfill the margin deposit requirement, the broker has the right to liquidate any or all securities or other assets held in the margin account at its discretion and without prior notice trader notifications.4 In order to prevent such forced liquidation, it is best to fulfill the margin deposit requirement and eliminate the margin shortfall immediately.
How to manage the risks associated with Margin trading?
Measures to manage the risks associated with margin trading include: using stop-loss orders to limit losses; limiting the amount of leverage to an acceptable level; attracting borrowed funds for a diversified portfolio to reduce the likelihood of a margin call, which is significantly higher in the case of a single stock.
Does the overall level of Margin debt affect market volatility?
A high level of margin debt can increase market volatility. During sharp market drops, customers are forced to sell shares to meet margin requirements. This can lead to a vicious circle, when strong pressure from sellers leads to lower stock prices, which entails an increase in margin requirements and an increase in sales.
Buying securities with margin is not a good idea for most investors who make savings to achieve long-term goals, such as retirement. The margin requirement will force you to increase your equity either by adding additional cash and securities, or by selling existing assets. Since margin requirements often arise during periods of strong volatility, you may be forced to sell securities at undervalued prices.