What is a margin call? Definition, how to avoid them

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  • A margin call occurs when the equity in your investment account drops to a certain level and you owe your brokerage firm money.
  • Margin calls should be satisfied by depositing money into the account or making up the difference you owe by selling assets or depositing other assets into the account.
  • Using margin can increase potential return but also magnify your losses.
  • Visit Insider’s Investment Reference Library for more stories.

A margin call occurs when the value of your brokerage account falls below a certain level. This level is known as the margin requirement and means that the investor is required to deposit more money into the account, sell some of their investments, or add more assets that may be subject by a margin if it is reached. “The best way to describe a margin call is that you owe your investment platform or brokerage money,” says Robert Farrington, founder of The College investor.

In the context of investing, margin is the practice of taking out a loan from the brokerage firm for the purpose of purchasing stocks and other assets. Margin can increase the purchasing power of an investor by allowing them to make larger investments and higher potential profits. “Margin is an incredible tool for providing investors with access to additional capital,” says Dr Hans Boateng, founder of The investment tutor. “It works wonders in a bull market. It becomes dangerous in a bear market if you don’t have savings on a margin call.”

How margin calls work

There are different types of margin calls and requirements depending on the type of account you have and the type of asset you can trade. Regardless of what type of account or what you invest in, once a margin call has taken place, you will need to bring the account to a minimum through the methods mentioned above. If the margin call is not satisfied quickly enough (typically 2-5 business days), then your brokerage may sell your positions, which could result in a taxable event.

There are three main types of margin calls: maintenance margin calls, T settlement calls, and minimum equity calls. Each of these margin calls can be triggered for different reasons. Here’s a breakdown of each below.

Maintenance margin call: A maintenance margin call refers to the margin requirement to stay in a position. Once you’ve reached the initial 50% margin requirement, the Financial Industry Regulatory Authority (FINRA) requires brokerage firms to set a hold requirement of at least 25% for the remainder of the trade. and allow brokerage firms to be even more restrictive. This is sometimes referred to as the “house requirement” and most brokerages set their maintenance requirements between 30-40%.

Let’s take an example where you have $ 10,000 invested in ABC Company: If your brokerage sets the maintenance margin requirement at 25%, that means your account equity should not drop below 2,500 $.

Remember that a margin account will include equity, which is the amount of money you have plus the amount loaned to you. Therefore, the total account balance would need to be $ 7,500 to receive a margin call ($ 5,000 margin loan + $ 2,500 remaining equity) because the loan value has not changed.

Here are some scenarios using a 25% maintenance margin requirement with $ 5,000 equity and $ 5,000 margin.

  • If the account value drops 10% to $ 9,000 = No maintenance margin call
    • Equity = $ 4,000
    • Margin balance = $ 5,000
  • If the account value drops 30% to $ 7,000 = maintenance margin call
    • Equity = $ 2,000
    • Margin balance = $ 5,000
    • Now you need to add at least $ 500 to the account
  • If the account value drops 40% to $ 6,000 = maintenance margin call
    • Equity = $ 1,000
    • Margin balance = $ 5,000
    • You must now add at least $ 1,500

Call of regulation T: This type of call refers to the requirements necessary to start a margin trade and can occur when an investor trades in a margin account without meeting the initial minimum 50% equity requirement. This is sometimes called Fed Call.

Minimum equity appeal: This is the lowest amount needed to open and maintain a margin account. This call – sometimes referred to as a trade call – occurs when the account balance drops below $ 2,000 in equity. If you are classified as a model day trader, this requirement is $ 25,000.

How to avoid margin calls

You don’t have to have a margin account and you can easily avoid margin calls by only trading with cash. “The best way to avoid a margin call is to simply not use up your entire margin limit,” says Farrington. Margin isn’t necessary to achieve strong, consistent returns over time, but for those who choose to use it, here are some steps you can take to avoid a margin call:

  • Keep cash on hand. One of the easiest ways to settle a margin call is to add money to the account. However, if you don’t keep enough cash on hand, it can be difficult.
  • Stop loss orders. Entering a stop loss order can help limit losses and, depending on the volatility that day, could prevent the stock from falling enough to trigger a margin call.
  • Stay informed. It is recommended that you do not check your investment account daily; however, this changes with a margin account due to the higher risk levels. Investors may consider adding alerts if the price falls within a certain range.
  • Use your margin limits wisely. Just because you have the option of taking out a large margin loan doesn’t mean you should. If you are using margin, consider using less than the maximum amount – this would give you a greater share of equity and a bigger cushion to avoid a margin call.

The financial report

Using margin in an investment account can help increase gains, but it can also magnify losses. It is important to make sure that you are managing your risk properly. “There is really little reason to use the margin,” Farrington adds. “It should only be used by experienced investors who have a specific plan and goal to do it. Maybe you invest today while waiting for that ACH deposit next week. Or maybe you run some. options strategy. But you have to have a specific plan. “


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