What is a Margin Call?
A margin call happens when a broker demands that an investor deposits additional money or securities so that the margin account is brought up to the minimum maintenance margin. A margin call occurs when the account value falls below the broker's required minimum value.
Basically, this 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.
- Margin calls are demands for additional capital or securities to bring a margin account up to the minimum maintenance margin.
- Brokers may force traders to sell assets, regardless of the market price, to meet the margin call if the trader doesn't deposit funds.
How Margin Calls Work
A margin call arises when an investor borrows money from a broker to make investments. When an investor uses margin to buy or sell securities, he pays for them using a combination of his own funds and borrowed money from a broker. An investor's equity in the investment is equal to the market value of securities minus borrowed funds from the broker.
A margin call is triggered when the investor's equity, as a percentage of the total market value of securities, falls below a certain percentage requirement, which is called the maintenance margin. While the maintenance margin percentage can vary among brokers, federal law establishes a minimum maintenance margin of 25%.
If a margin call is not met, a broker may close out any open positions to bring the account back up to the minimum value without your approval. The broker may also charge you a commission on the transaction(s). You are responsible for any losses sustained during this process.
The best way to avoid margin calls is to use protective stop orders to limit losses from any equity positions, as well as keep adequate cash and securities in the account.
Real World Example of a Margin Call
An investor buys $100,000 of Apple Inc. using $50,000 of his own funds and borrowing the remaining $50,000 from the broker. The investor's broker has a maintenance margin of 25%. At the time of purchase, the investor's equity as a percentage is 50%.
Investor's Equity As Percentage = (Market Value of Securities - Borrowed Funds) / Market Value of Securities
In our example: 50% = ($100,000 - $50,000) / ($100,000)
This is above the 25% maintenance margin, but suppose on the second trading day, the value of the purchased securities falls to $60,000. This results in the investor's equity of $10,000 (the market value of $60,000 minus the borrowed funds of $50,000), or 16.67%.
16.67% = ($60,000 - $50,000) / ($60,000)
This is now below the maintenance margin of 25%. The broker makes a margin call, requiring the investor to deposit at least $5,000 to meet the maintenance margin. The amount required to meet the maintenance margin is calculated as:
Amount to Meet Minimum Maintenance Margin = (Market Value of Securities x Maintenance Margin) - Investor's Equity
In our example, the required $5,000 is calculated as:
$5,000 = ($60,000 x 25%) - $10,000
The investor needs at least $15,000 of equity (the market value of securities of $60,000 times the 25% maintenance margin) in his account to be eligible for margin, but only has $10,000 in investor's equity, resulting in a $5,000 deficiency. The margin call is for $5,000, and if the investor does not deposit the money in a timely manner, the broker can liquidate securities for the value sufficient to bring the account into compliance with the maintenance margin rules.