Margin trading, where investors borrow money from a broker to trade financial products, requires a margin call. This configuration uses an investor's margin account as collateral, both their own and borrowed money. The broker's maintenance requirement triggers the margin call when the investor's equity falls below it.

The broker sends a margin call when marketing losses lower equity, requiring the investor to deposit more dollars or securities immediately and restoring account equity to the broker-mandated minimum. Regardless of market conditions, the broker can sell some of the investor's assets to fund the margin call.

Margin calls can also occur when a short seller loses when a borrowed stock increases. Investors must closely check their account equity and keep enough cash to prevent margin calls. Successful margin trading requires balancing capital leverage for gains with risk management to avoid margin calls and asset liquidation.

Margin Calls Triggers

The New York Stock Exchange (NYSE) and the Financial Industry Regulatory Authority (FINRA) determine the maintenance margin, the minimum proportion of securities an investor must hold as equity in their margin account. For example, NYSE and FINRA need 25% maintenance margins. Individual brokerage firms may need 30% to 40% more. A margin call occurs when an investor's equity falls below the maintenance margin.

This can be caused by a drop in the account's securities' market value or transaction losses. Market volatility increases margin calls since price swings can swiftly deplete an investor's equity. The broker requests that the investor deposit more dollars or securities during a margin call to restore equity. Failure to pay this demand may require the broker to liquidate assets. Investors must watch account equity and market volatility to prevent margin calls.

Example of Margin Call

This example shows how a broker's margin call is triggered by a change in the value of assets in a margin account, highlighting the investor's equity and the necessary measures. The investor uses $10,000 of their capital and $10,000 from the broker to buy a $20,000 investment. The investor's equity is $10,000, 50% of the market value. Investors often leverage their funds to boost returns in margin trading.

As the security's market value decreases to $14,000, things change. The investor still owes the broker $10,000 despite the value drop. Thus, the investor's equity drops to $4,000, 28% of the updated market value. This equity drop below the broker's maintenance requirement triggers a margin call. This scenario requires $4,200 in upkeep, 30% of the market value. Due to the investor's $200 equity drop, the broker makes a margin call, requiring the investor to deposit more dollars or securities.

Failure to meet the margin call might result in the broker liquidating margin account assets to raise equity. Forced liquidation at poor market prices may worsen the investor's financial situation. This example highlights the risks of margin trading and the importance of monitoring account equity to avoid margin calls, highlighting the delicate balance between leveraging funds for potential gains and managing the dangers to prevent financial harm.

Covering Margin Calls

Investors whose account value has dropped to a level triggering a broker margin call must cover it. A margin call implies that the investor's equity has fallen below the maintenance margin requirement and requires immediate action to restore compliance. Investors have many margin call coverage options:

Deposit Cash

Investors might put more money into their margin account. For example, an investor can deposit $200 to fulfill a $200 margin call.

Deposit Margin-able Securities

Investors can cover margin calls by depositing marginable securities. These securities add to account equity when wholly paid for. Divide $200 by the inverse of the equity requirement (1 minus the 30% equity requirement) to calculate the securities needed to pay the margin call. The example requires $285 marginal securities.

Sell Other Securities

The investor can also sell other securities in their portfolio to get cash. This strategy liquidates assets to make up the difference and restore account equity.

Investors must act quickly since brokers typically give investors two to five days to fulfill the margin call. If an investor fails to respond, the broker may close open positions to replenish the account. The broker may impose commissions for forced liquidation without investor agreement. Any losses throughout this procedure are the investor's responsibility. Prompt and intelligent decision-making is necessary to overcome margin calls and safeguard one's investment portfolio.

Avoiding Margin Calls

Investors should carefully analyze if margin trading risks match their investing goals before using a margin account. Long-term investors may not see the benefits of margin trading outweigh the dangers since brokerages charge interest on these loans, adding to the investment process. Investors might keep cash in their accounts to minimize margin calls and ensure rapid access to capital. This preventive technique allows margin requirements to be met without asset liquidation as a first line of defense.

Margin call risk can be reduced by diversification. In a well-diversified portfolio, investors distribute risk across assets, lessening the impact of a single position drop on account value. Diversity reduces risk by reducing the likelihood of a margin call review due to a security's poor performance. Proactive risk management requires portfolio monitoring, including open positions, equity, and margin borrowing. Investors should evaluate their portfolios daily to monitor market fluctuations and investment success. Custom alarms above margin upkeep provide early warning. These notifications encourage investors to act quickly if their account approaches a crucial level. Investors can deposit more cash or securities to prevent a margin call in the case of an alarm.

Margin calls need rapid action. Ignoring or postponing a margin call might compel asset liquidation under unfavorable market conditions. Effective risk management in margin trading requires a plan for addressing margin calls, whether with cash, securities, or both.

Risk Associated With Margin Calls

Margin trading increases stock trading risks by borrowing money to leverage investments. Margin calls are the main risk. Investors must quickly deposit dollars or securities if security values drop, prompting a margin call. Failure to comply may result in forced liquidation at disadvantageous market pricing. The most significant risk of margin trading is losing more than the initial investment because investors may have to cover the borrowed amount and the investment.