DEFINITION of Liquidation Margin
Liquidation margin is the value of all of the equity positions in a margin account. (Margin accounts are customer accounts held with a broker-dealers that allow investors to buy securities with funds borrowed from the broker.) Liquidation margin applies to investors or traders who use margin (leverage) to increase the potential profit of a trade.
BREAKING DOWN Liquidation Margin
Investor cash funds or holdings designated as eligible securities in margin accounts serve as collateral to support their borrowings. Brokers specify requirements for securities deemed to be eligible to use for collateral. Generally, they must be highly liquid (stocks, ETF, or bonds), trade on a major exchange, and have a minimum trading price.
If an investor or trader holds a long position, the liquidation margin is equal to what the investor or trader would retain if the position were closed. If an investor or trader has a short position, the liquidation margin is equal to what the investor or trader would owe to purchase the stock or other trading instrument. When the equity of a margin account falls below the liquidation margin level requirement, the broker may automatically close any open positions in the account.
Example of Liquidation Margin
For example, Sarah’s brokerage account has a negative $5,000 liquidation margin. When her broker makes its margin call, she is required to deposit funds of at least $5,000 into the account to meet the maintenance margin. If she is unable to make the payment, her broker is entitled to liquidate the funds in her account in order to raise enough cash to meet its margin requirements. Depending on the terms of the account agreement Sarah signed with her broker, she may or not be notified in advance of the sales. In some cases, she might not even receive a call concerning her account’s liquidation margin before her broker decides to liquidate open positions.
These types of forced sales of positions in the account in order to meet margin requirements, do not require customer approval. Customers’ margin agreements spell out the terms associated with their accounts including what if any notice period the broker must observe before selling securities in your account to meet margin calls. In a worst-case scenario, securities sales can be made at times when stock prices are depressed — and they might still not be enough to meet margin calls, or the funds owed to the broker. In that case, the losses could be substantial.