Margin Call: What It Is and How to Meet One with Examples
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Summary:
Margin trading allows investors to trade with borrowed funds, allowing them to increase their purchasing power and potentially amplify their profits. However, it also carries significant risks, including the possibility of incurring losses beyond the original investment. When the value of securities purchased with borrowed funds falls, an investor may be required to deposit additional funds into their margin account to meet the minimum equity requirements. Failure to do so can result in a margin call.
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What is a margin call?
A margin call is a notification from your broker requesting that you deposit additional funds into your margin account to meet the minimum equity requirements. It is triggered when the value of securities purchased with borrowed funds falls, reducing the investor’s equity in the account below the broker’s required maintenance margin level.
What triggers a margin call?
Several factors can trigger a margin call, including:
- Decrease in the value of the securities in the account
- Increase in the margin requirement by the broker
- Increase in interest rates
When any of these factors occur, it can lead to a reduction in the account’s equity and a possible margin call.
Example
Let’s say an investor has a margin account with a $10,000 balance and $20,000 in securities. This means the account has a 2:1 leverage ratio. If the value of the securities drops by 25%, the account’s equity would decrease by 50% to $10,000. This would bring the margin level down to 50%, which is below the broker’s maintenance margin level of 60%. As a result, the investor would receive a margin call, requiring them to deposit additional funds into their account to bring it back to the required level.
How to cover a margin call
When you receive a margin call, there are several ways to cover it, including:
- Depositing additional funds into the margin account
- Selling securities to raise cash
- Both depositing funds and selling securities
It’s important to act quickly when you receive a margin call, as failing to meet the call can result in the broker selling securities in the account to cover the shortfall, potentially incurring significant losses.
PRO TIP: Always have a plan in place before you start trading on margin. This means understanding your risk tolerance and setting clear stop-loss orders to limit potential losses.
How to avoid a margin call
Here are some tips to help you avoid a margin call:
- Keep a close eye on your account’s equity level and margin requirements
- Avoid overleveraging your trades
- Consider setting stop-loss orders to limit losses
Margin call FAQs
What happens if I ignore a margin call?
Ignoring a margin call can result in the broker liquidating securities in your account to cover the shortfall, potentially resulting in significant losses.
Can I negotiate a margin call with my broker?
It is possible to negotiate a margin call with your broker, but it’s not guaranteed. Your broker may be willing to extend the deadline for meeting the call or work with you to develop a repayment plan.
How often can I receive a margin call?
Margin calls can occur as frequently as daily, depending on market conditions and the broker’s policies.
Key takeaways
- A margin call is a demand from a broker for an investor to add more funds or securities to their account to bring it back to the required minimum level.
- A margin call is triggered when the investor’s account value falls below the broker’s required maintenance margin.
- To meet a margin call, an investor can add more funds, sell securities, or transfer securities from another account.
- To avoid a margin call, investors should monitor their accounts regularly, avoid over-leveraging, and have a solid understanding of margin trading rules and risks.
- Margin trading can amplify both gains and losses, and investors should carefully consider their risk tolerance before engaging in this strategy.
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