What triggers a margin call and how can you avoid it?
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What Is a Margin Call and Why Does It Happen?
A margin call occurs when your broker requests additional funds because your trading account no longer meets the required margin levels. This usually happens after unfavorable price movements reduce the value of the assets in your account.
A margin call may arrive in different forms—such as an email, a text message, a platform notification, or sometimes no warning at all. A typical notice may look something like this:
“Your trading account shows a debit balance due to recent trades. The losses must be covered by depositing additional funds. If the margin requirement is not restored, your collateral may be liquidated.”
Brokers issue margin calls to ensure that investors can repay the money borrowed to purchase securities on margin. When trading through a Margin Trading account, you are effectively using funds loaned by the broker to increase your purchasing power.
If you fail to respond to the margin call by depositing additional funds or closing positions, the broker may automatically sell some or all of the assets in your account. This liquidation can happen without prior notice, and the broker typically has full discretion over which securities are sold to restore the required margin balance.
What is a margin call?
Buying on margin
Before you open a margin account, make sure you understand what buying on margin means. Buying on margin is buying more securities than you can afford, using your broker’s money.
Why would you do that?
“Customers generally use margin to leverage their investments and increase their purchasing power. At the same time, customers who trade securities on margin incur the potential for higher losses.”
Financial Industry Regulatory Authority (FINRA)
What Is Margin and How Does Margin Trading Work?
Margin allows investors to purchase securities by borrowing money from their broker and using the purchased assets as collateral for the loan. This approach enables investors to buy more stocks than they could with only their own capital. Because the borrowed money functions as a loan, the investor must also pay interest on the amount borrowed.
To trade using margin, you cannot use a standard cash account. Instead, you must open a margin account, which typically requires a higher minimum balance. According to rules set by the Financial Industry Regulatory Authority (FINRA), the minimum balance required to open a margin account is $2,000, often referred to as the minimum margin requirement.
However, this minimum amount may not be sufficient to satisfy your broker’s initial margin requirement, which usually allows investors to borrow up to 50% of the value of a stock purchase. The portion of the purchase that you fund with your own money is known as your initial equity in the account.
Maintenance Margin Requirements
After purchasing securities on margin, investors must continue to maintain a certain level of equity in their accounts. This is known as the maintenance margin requirement.
Your account equity is calculated as:
Equity = Current market value of securities – Amount borrowed from the broker
Under FINRA regulations, the equity in a margin account must remain at least 25% of the total market value of the securities held in the account. If your equity falls below this level due to market losses, you may receive a margin call requiring you to deposit additional funds or securities.
While the regulatory minimum is 25%, brokers are allowed to set their own maintenance margin thresholds. In practice, many brokers require between 25% and 40% equity, depending on factors such as the volatility of the securities being traded. This minimum equity level must be maintained at all times to avoid forced liquidation of positions.
“Firms have the right to set their own margin requirements—often called “house” requirements—as long as they are higher than the margin requirements under Regulation T or the rules of FINRA and the exchanges. Firms can raise their maintenance margin requirements for specific volatile stocks to ensure there are sufficient funds in their customers’ accounts to cover large price swings.”
FINRA
What is a margin call?
What triggers a margin call and how can you avoid it?
When do you get the dreaded margin call?
One scenario that triggers a margin call is when the value of your assets drops below the initial margin requirement.
You also get the call when the value of your margin account falls to or below the maintenance margin level. Your broker will ask you to restore the account to the original level. If you don’t do as you’re told, the broker will liquidate some of your assets. In fact, sometimes your broker may sell off your assets without even making a margin call.
“And here’s an important reality check: a firm is not required to notify you of the sale, though most do so as a courtesy; nor does the firm let you choose which securities or assets are sold to meet a margin call.”
FINRA
What can you do to avoid a margin call?
First of all, carefully read the margin agreement and understand the terms and conditions. If something is not clear, ask your broker to explain it!
Monitor margin requirements. This includes checking market prices at least on a daily basis. You can try to set market alerts on your broker’s web, desktop or mobile trading platform.
In case of adverse price movements that bring you dangerously close to the margin requirement, deposit additional cash into your margin account. And that’s not all! Keep watching the market because you might have to make additional deposits to avoid the call in case the price drop continues.
Some brokers offer tools to help you calculate the impact of equity trades on your margin account. Use them!
What is a margin call?
Margin call scenarios
Let’s have a look at a margin call scenario!
Let’s say you have $1,000 and you want to buy stocks on margin.
- Ask your broker to approve you for a margin account
- If you get the approval, you must meet the initial margin requirement. With your $1,000 you can buy $2,000 worth of stocks
- Now you have $1,000 equity and $1,000 debt, a loan from your broker in your margin account. This is called the margin loan balance.
Let’s say that your broker has a 40% maintenance margin requirement. Going forward, make sure you always meet this requirement – at the current stock price, this would be $2,000 x 0.4 = $800.
What happens if the price of the stock rises by 25%?
- In this case, your account is worth $2,500.
- If you decide to sell the shares, you make $2,500 – $1,000 = $1,500 after you pay back the $1,000 loan to your broker. That’s a 50% return on your initial investment of $1,000. Not bad, right?
What happens if the stock price drops by 25%?
- The market value of your stocks is now at $1,500.
- The equity in your account drops to $1,500 – $1,000 = $500. Remember, this is the current market value of your stocks minus the debt you owe to your broker.
- With a market value of $1,500, you would need to maintain equity of $1,500 x 0.4 = $600 in your account to meet the maintenance margin requirement.
- A margin call will be issued on your account because you don’t meet the margin requirement.
- You will be required to urgently deposit cash or sell off some of your securities to meet the margin requirement again.
- Remember that your broker may sell your stocks without calling you first!