Margin Trading: The Dreaded Margin Call
AAA
  1. Margin Trading: Introduction
  2. Margin Trading: What Is Buying On Margin?
  3. Margin Trading: The Dreaded Margin Call
  4. Margin Trading: The Advantages
  5. Margin Trading: The Risks
  6. Margin Trading: Conclusion
Margin Trading: The Dreaded Margin Call

Margin Trading: The Dreaded Margin Call

In the previous section, we discussed the two restrictions imposed on the amount you can borrow. First, the initial margin, which is the initial amount you can borrow. Second, the maintenance margin, which is the amount you need to maintain after you trade. These amounts are set by the Federal Reserve Board, as well as your brokerage. Individual brokerages can have stricter limits, but the Federal Reserve Board sets a minimum initial margin of 50% and a maintenance margin of at least 25%.

Our focus in this section is the maintenance margin. In volatile markets, prices can fall very quickly. If the equity (value of securities minus what you owe the brokerage) in your account falls below the maintenance margin, the brokerage will issue a "margin call". A margin call forces the investor to either liquidate his/her position in the stock or add more cash to the account.

Here's how it works. Let's say you purchase $20,000 worth of securities by borrowing $10,000 from your brokerage and paying $10,000 yourself. If the market value of the securities drops to $15,000, the equity in your account falls to $5,000 ($15,000 - $10,000 = $5,000). Assuming a maintenance requirement of 25%, you must have $3,750 in equity in your account (25% of $15,000 = $3,750). Thus, you're fine in this situation as the $5,000 worth of equity in your account is greater than the maintenance margin of $3,750. But let's assume the maintenance requirement of your brokerage is 40% instead of 25%. In this case, your equity of $5,000 is less than the maintenance margin of $6,000 (40% of $15,000 = $6,000). As a result, the brokerage may issue you a margin call.

If for any reason you do not meet a margin call, the brokerage has the right to sell your securities to increase your account equity until you are above the maintenance margin. Even scarier is the fact that your broker may not be required to consult you before selling! Under most margin agreements, a firm can sell your securities without waiting for you to meet the margin call. You can't even control which stock is sold to cover the margin call.

Because of this, it is imperative that you read your brokerage's margin agreement very carefully before investing. This agreement explains the terms and conditions of the margin account, including: how interest is calculated, your responsibilities for repaying the loan and how the securities you purchase serve as collateral for the loan.

Margin Trading: The Advantages

  1. Margin Trading: Introduction
  2. Margin Trading: What Is Buying On Margin?
  3. Margin Trading: The Dreaded Margin Call
  4. Margin Trading: The Advantages
  5. Margin Trading: The Risks
  6. Margin Trading: Conclusion
Margin Trading: The Dreaded Margin Call
RELATED TERMS
  1. Bid Wanted

    An announcement by an investor who holds a security that he or ...
  2. Multibank Holding Company

    A company that owns or controls two or more banks. Mutlibank ...
  3. Short Put

    A type of strategy regarding a put option, which is a contract ...
  4. Wingspread

    To maximize potential returns for certain levels of risk (while ...
  5. Volatility Smile

    A u-shaped pattern that develops when an option’s implied volatility ...
  6. Nadex

    Nadex stands for the North American Derivatives Exchange, a regulated ...
  1. How do I calculate the adjusted closing price for a stock?

    When trading is done for the day on a recognized exchange, all stocks are priced at close. The price that is quoted at the ...
  2. How do I find historical prices for stocks?

    Whether for research purposes, bookkeeping or even general interest in historical performance, this is a question that many ...
  3. What's the difference between binary options and day trading?

    Binary options and day trading are both ways to make (or lose) money in the financial markets, but they are different animals. ...
  4. If a LEAP option is purchased and held for more than 12 months, is the tax treatment ...

    A LEAP (long-term equity anticipation security) is a call or put option that allows the buyer a long-term expiration on the ...
comments powered by Disqus
Related Tutorials
  1. Stock Basics Tutorial
    Investing Basics

    Stock Basics Tutorial

  2. Binary Options Tutorial
    Options & Futures

    Binary Options Tutorial

  3. Top ETFs And What They Track: A Tutorial
    Mutual Funds & ETFs

    Top ETFs And What They Track: A Tutorial

  4. Introduction to Stock Trader Types
    Active Trading Fundamentals

    Introduction to Stock Trader Types

  5. Beginner's Guide To Trading Futures
    Options & Futures

    Beginner's Guide To Trading Futures

Trading Center