A margin call occurs when the percentage of an investor’s equity in a margin account falls below the broker’s required amount. An investor’s margin account contains securities bought with a combination of the investor’s own money and money borrowed from the investor’s broker.
A margin call refers specifically to a broker’s demand that an investor deposits additional money or securities into the account so that the value of the investor’s equity (and the account value) rises to a minimum value indicated by the maintenance requirement.
A margin call is usually an indicator that securities held in the margin account have decreased in value. When a margin call occurs, the investor must choose to either deposit additional funds or marginable securities in the account or sell some of the assets held in the account.
What Triggers a Margin Call?
When an investor pays to buy and sell securities using a combination of their own funds and money borrowed from a broker, the investor is buying on margin. An investor’s equity in the investment is equal to the market value of the securities minus the borrowed amount.
A margin call is triggered when the investor’s equity, as a percentage of the total market value of securities, falls below a certain required level (called the maintenance margin).
The New York Stock Exchange (NYSE) and the Financial Industry Regulatory Authority (FINRA)—the regulatory body for the majority of securities firms operating in the United States—each require that investors maintain an equity level of 25% of the total value of their securities when buying on margin.23 Some brokerage firms require a higher maintenance requirement, sometimes as much as 30% to 40%.
Margin calls can occur at any time due to a drop in account value. However, they are more likely to happen during periods of market volatility.
Example of a Margin Call
Here’s an example of how a change in the value of a margin account decreases an investor’s equity to a level where a broker must issue a margin call.
|Security bought for $20,000 (half on margin)
|Investor Equity = $10,000
|Investor Equity = 50%
|Value drops to $14,000
|Investor Equity = 28%
|The maintenance requirement of the broker
|Resulting margin call
How to Cover a Margin Call
If an investor’s account value drops to a level where a margin call is issued by their broker, the investor typically has two to five days to meet it. Using the margin call example above, here are the options for doing so:
- Deposit $200 in cash into the account.
- Deposit $285 of marginal securities (fully paid for) into your account. This amount is derived by dividing the required funds of $200 by (1 less the 30% equity requirement): 200/(1-.30) = $285.
- Use a combination of the above two options.
- Sell other securities to obtain the needed cash.
If an investor isn’t able to meet the margin call, a broker may close out any open positions to replenish the account to the minimum required value. They may be able to do this without the investor’s approval. Furthermore, the broker may also charge an investor a commission on these transaction(s). This investor is held responsible for any losses sustained during this process.
How to Avoid a Margin Call
Before opening a margin account, investors should carefully consider whether they need one. Most long-term investors don’t need to buy on margin to earn solid returns. Plus, the loans aren’t free. Brokerages charge interest on them.
However, if you wish to invest with margin, here are a few things you can do to manage your account, avoid a margin call, or be ready for it if it comes.
- Make sure cash is available to place in your account immediately. Consider keeping it in an interest-earning account at the same brokerage.
- Build a well-diversified portfolio. It may help limit margin calls since a single position is less likely to decrease the account value.
- Monitor your open positions, equity, and margin loans regularly (even daily).
- Create a custom-made alert at some comfortable level above the margin maintenance requirement. If your account falls to it, deposit funds or securities to increase your equity.
- If you receive a margin call, take care of it immediately.
In addition to keeping adequate cash and securities in their account, a good way for an investor to avoid margin calls is to use protective stop orders to limit losses in any equity positions.
Is It Risky to Trade Stocks on Margin?
It is certainly riskier to trade stocks with a margin than without it. This is because trading stocks on margin is trading with borrowed money. Leveraged trades are riskier than unleveraged ones. The biggest risk with margin trading is that investors can lose more than they have invested.
How Can a Margin Call Be Met?
A margin call is issued by the broker when there is a margin deficiency in the trader’s margin account. To rectify a margin deficiency, the trader has to either deposit cash or marginable securities in the margin account or liquidate some securities in the margin account.
Can a Trader Delay Meeting a Margin Call?
A margin call must be satisfied immediately and without any delay. Although some brokers may give you two to five days to meet the margin call, the fine print of a standard margin account agreement will generally state that to satisfy an outstanding margin call, 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 to the trader.4 To prevent such forced liquidation, it is best to meet a margin call and rectify the margin deficiency promptly.
How Can I Manage the Risks Associated with Trading on Margin?
Measures to manage the risks associated with margin trading include: using stop-loss orders to limit losses; keeping the amount of leverage to manageable levels; and borrowing against a diversified portfolio to reduce the probability of a margin call, which is significantly more likely with a single stock.
Does the Total Level of Margin Debt Have an Impact on Market Volatility?
A high level of margin debt may exacerbate market volatility. During steep market declines, clients are forced to sell stocks to meet margin calls. This can lead to a vicious circle, where intense selling pressure drives stock prices lower, triggering more margin calls and more selling.
The Bottom Line
Buying on margin isn’t for everyone. While it can give investors more bang for their buck, there are downsides. For one, it’s only an advantage if your securities increase enough to repay the margin loan (and the interest on it). Another headache can be the margin calls for funds that investors must meet.
A margin call may require you to deposit additional cash and securities. You may even have to sell existing holdings. Or you may have to close out the margined position at a loss. Since margin calls can occur when markets are volatile, you may have to sell securities to meet the call at lower-than-expected prices.
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