What Is A Margin Call. Everything You Need To Know

What is a margin call? How does it differ from other types of calls? And why should I care?

In today's post, I will be going over the basics of what a margin call is, how to handle them and when you should consider getting one. A margin call is something you must have an understanding of if you want to trade with margin. And if you don't trade with margin like myself, it's still handy to know.

What Is a Margin Call

A margin call occurs when there’s not enough money in your brokerage accounts to cover your margin debt – the amount of cash needed to buy stocks. When your margin balance falls below a certain level, your broker will contact you.

You might receive a phone call or email asking about your trading activity. If you don’t respond quickly enough, your broker could sell some of your holdings to meet your margin requirements. This type of action is called a margin call.

In times of financial crisis many investors may go through margin calls on their margin trading accounts. If the stock price goes too low then a margin call will be triggered. If you can't pay the requested amount from the margin call then your assets may have to be sold in order to cover the costs. Brokerage firms are required by law to give you at least 48 hours notice before they can liquidate any securities held for you.

The point in which the margin call takes place is when the total value goes below the maintenance margin requirement. This is where the investor will have to add additional collateral to their trading account so their total balance is above the initial margin requirement.

Minimum Margin

The minimum margin requirement refers to the minimum amount of money required to open a margin account. A margin account allows traders to borrow funds against securities held in their portfolios.

Initial margin is the amount of cash needed to open a margin account; it is usually equal to 20% of the value of the security being purchased.

Maintenance margin is the minimum amount needed to keep trading positions open. For example, if you are long one contract for $10,000 and short another contract for $5,000, you would have maintenance margin of $5,000. If you close out both contracts, you would still owe maintenance margin of $5k.

Regulation T states that investors must maintain a minimum amount in cash reserves. Regulation T requires brokers to establish a reserve fund for each customer, consisting of cash or securities worth at least 5 times the initial margin requirements.

A broker cannot sell stocks or options unless there is sufficient cash in the account. Brokers are prohibited from purchasing securities for customers who do not meet the minimum margin requirements.

Margin Pros and Cons

Margin can definitely be helpful for increasing profits and accelerating your investment journey, however they are also very risky with one of those risks being the margin call. Below are some more pros and cons on using Margin

Pros

You can make more money than you would purchasing without margin by keeping the additional profit from the borrowed money

If you are confident in your investment/trading decisions then you can use margin opportunistically to increase high conviction profits

Cons

You need to have a minimum account balance to trade with margin

There's no guarantee of making any money.

Margin calls can wipe out large proportions of your position. Especially with high levels of margin.

What Happens During a Margin Call?

A margin call is an order from a broker to increase your cash balance. If you don't do it, he'll sell off some securities in your account to cover the difference. But there are ways to avoid getting hit with a margin call.

Margin calls can destroy your financial security. They're designed to give brokers the ability to protect themselves if they think you might default on your debt.

In the next section I cover some ways you can help make sure you don't end up in a situation where you are being margin called.

How to Avoid a Margin Call

Margin calls are one of the most stressful things about investing. They happen when there isn't enough money left in your account to cover the amount borrowed. A margin call is triggered when your equity drops below the maintenance margin set by your broker. If it does, your broker will ask you to either liquidate some securities or make up the difference.

If you don't act fast, you could lose everything. But making sure you're covered is easy. Here's how to avoid a margin call.

1. Know what triggers a margin call.

A margin call happens when your equity falls below your maintenance margin. You'll know whether your equity is low because your broker will send you a notice.

2. Calculate your maintenance margin.

Your maintenance margin is the amount of equity you must maintain above the value of your investments to prevent a margin call. This number varies depending on your broker. To find out what your maintenance margin is, contact your broker.

3. Understand the risks associated with margin trading.

When you use margin, you assume the risk that your investments may fall in value. Your broker can help protect you from this risk by requiring you to maintain a certain level of equity.

4. Make sure you have enough cash available.

Make sure you have enough cash on hand to cover any losses if your investments drop in value. If you don't, you could be forced to sell assets at a loss.

Summary

The term “margin” has many meanings. In finance, it refers to the amount of money you need to invest in stocks, bonds, mutual funds, etc., before you can purchase them. The word “margin” also means the amount of money you put into a stock or bond trade.

In general, the higher the margin, the greater the potential profit. On the other hand, the higher the margin required, the greater the risk involved. Margin can be great tool if used correctly however, it the extreme risk deters many people. Personally, I don't trade with margin due to the inherent risk.

I am not a financial advisor and anything I say in my blog is not to be taken as financial advise. For any financial advise please contact a financial professional. My blog is based on my own opinions, research and understanding of the financial markets.

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