A margin account lets you leverage your buying power and buy more stocks than you could with your available cash by taking on a loan from your broker. The stocks purchased themselves are then held as collateral by the brokerage firm.
The brokerage firm and the investor must follow many rules when buying securities on margin. The Federal Reserve Board sets the rules for margin requirements. If these requirements are not met, an account holder can receive either a maintenance margin call or a fed margin call. Essentially, if the account balance falls too low because the securities purchased lose value, you will have to add more money to the account or else face a forced liquidation of your shares and some pretty hefty losses.
- Trading on margin involves taking a loan from your broker in order to leverage your long position or go short stocks in the market.
- Because of this borrowing, if the securities held lose value, your loan will soon be "underwater," with the value of the securities held as collateral less than the loan itself.
- A margin call is then enforced, requiring you to add more money to your margin account so that the loan is no longer underwater.
- A federal margin call (Reg. T) is a legal requirement to fund a purchase of securities in a margin account with at least 50% cash.
- Maintenance margin is the minimum amount of equity that an investor must maintain in the margin account after the purchase has been made, currently set at 25% of the total value of the securities.
- Failure to meet initial margin can result in the prevention of trading, or the forced liquidation of other securities by one's broker in order to meet the margin requirement.
A margin call occurs when the value of an investor's margin account (that is, the one that contains securities bought with borrowed money) falls below the broker's required amount. A margin call is the broker's demand that an investor deposit additional money or securities so that the account is brought up to the minimum value, known as the maintenance margin.
A margin call usually means that one or more of the securities held in the margin account has decreased in value below a certain point. The investor must either deposit more money in the account or sell some of the assets held in the account.
Maintenance Margin Calls
A maintenance margin is set after the initial purchase. The Federal Reserve Regulation T sets this requirement at 25%, although many brokerage firms require more, such as 30% to 40%. A maintenance margin at 25% means a minimum equity amount must be valued at 25% or more of the margin account's total value.
If one or more securities in the account fall below a certain price, and these requirements are not met, the investor receives a maintenance margin call. Depositing money or marketable securities to increase the equity in the account or selling positions in the account to pay down the loan will satisfy the maintenance margin call.
Fed Margin Calls
Regulation T states an initial margin must be at least 50%, although many brokerage firms set their requirements higher at 70%. This means an investor must pay 50%, or more if the brokerage firm requires it, of the security's purchase price upfront. This is known as a federal (or 'fed') margin call.
When an investor purchases stocks and does not have enough equity in the account to meet the 50% equity requirement, a fed margin call, also called a Regulation T margin call, is triggered. Depositing money or marketable securities will satisfy the fed call. If it is not satisfied, a liquidation violation may be placed on the margin account.