A margin call is when a broker requires that an account holder deposit more capital into their account or sell an open position to maintain it at the required minimum security value for margin requirements. A margin call happens when the value of a trader’s margin account of borrowed money drops below the broker’s requirement ratio for the live positions being held.
A margin call usually takes place as a result of the drop in value of holdings going below the amount needed to maintain the ratio of margin maintenance between holdings and the margin loans for the current positions. When a trader receives a margin call they can either deposit more money into the account to bring it back inside the margin parameters or sell some of the assets to decrease loan requirements.
A margin call is a sign of poor risk management with both using leverage and also not setting stop losses to avoid the situation. The best response for a margin call is to exit all positions and reevaluate position size parameters.
FINRA and The New York Stock Exchange (NYSE) require investors and traders to maintain a minimum of 25% of their total account value of their holdings as margin. Brokers can all have different margin requirements with higher maintenance parameters, many need 30% to 50% of account holdings for margin. Also different stocks and futures contracts have different individual margin requirements based on specific volatility and risk.
An example of a margin call is if a trader is buying a stock for $100 with a beginning margin of 50% then they are using $50 of their own capital to buy the stock and borrowing the the other $50 from a broker on margin. Also, the maintenance margin is 25%. The trader would receive a margin call if the price of the stock falls below $66.67.
So if the account size was $50,000 and the trader took a trade in a thousand shares of a $100 stock for a $100,000 position size then if the stock dropped to $66.67 and the account went to $66,670 this would trigger a margin call due to a not maintaining the 25% margin maintenance.
- The trader is buying a stock for $100 with $50 of his own capital and $50 of margin.
- Their broker’s maintenance margin requirement is 25%, this means the trader’s own capital must be a minimum of 25% of the stock position at all times.
Because the broker lent the trader $50 to buy the stock and it is now trading at $66.67, the broker’s lent money comprises 75% of the trade or $50 of the $66.67 value or $50/$66.67 = 74.9%, while the trader’s own capital makes up only 25% of the position.
Leverage is a great tool for turning over capital quickly for different trading positions and not having to wait for the trade to clear to reset buying power of capital but it can be very dangerous for trading too big and risking ruin. Always use margin responsibly inside proper risk management parameters.
