What Is a Margin Call?
A margin call occurs when the value of an investor's margin account (that is, 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.
- A margin call occurs when a margin account runs low on funds because of a losing trade.
- 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. If a margin call is not met, the broker may be forced to liquidate securities in the account at the market.
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. The New York Stock Exchange (NYSE) and FINRA require investors to keep at least 25% of the total value of their securities as margin. Many brokerage firms may require a higher maintenance requirement—as much as 30% to 40%.
Obviously, the figures and prices with margin calls depend on the percent of the margin maintenance and the equities involved. But in individual instances, the exact stock price below which a margin call will be triggered can be calculated. Basically, it will occur when the account value, or account equity, equals the maintenance margin requirement (MMR). The formula would be expressed as:
Account Value = (Margin Loan) / (1-MMR)
Let’s say you open a margin account with $5,000 of your own money and $5,000 borrowed from your brokerage firm as a margin loan. You purchase 200 shares of a marginable stock at a price of $50 (under the Federal Reserve Board’s Regulation T, you can borrow up to 50% of the purchase price). Assume that your broker's maintenance margin requirement is 30%.
Your account has $10,000 worth of stock in it. In this example, a margin call will be triggered when the account value falls below $7,142.86 (i.e. margin loan of $5,000 / (1 – 0.30), which equates to a stock price of $35.71 per share.
What Happens After a Margin Call
Using the example above, let's say the price of your stock falls from $50 to $35. Your account's now worth $7,000, and it triggers a margin call of $100.
You have one of three choices to rectify your margin deficiency of $100:
- Deposit $100 cash in your margin account, or
- Deposit marginable securities worth $142.86 in your margin account, which will bring your account value back up to $7,142.86, or
- Liquidate stock worth $333.33, using the proceeds to reduce the margin loan; at the current market price of $35, this works out to 9.52 shares, rounded off to 10 shares.
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. That means the broker has the right to sell any stock holdings, in the requisite amounts, without letting you know. Furthermore, the broker may also charge you a commission on these 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 is calculated as: Investor's Equity As Percentage = (Market Value of Securities - Borrowed Funds) / Market Value of Securities. So, in our example: ($100,000 - $50,000) / ($100,000) = 50%.
This is above the 25% maintenance margin. So far, so good. But suppose, two weeks later, the value of the purchased securities falls to $60,000. This results in the investor's equity tumbling to $10,000 (the market value of $60,000 minus the borrowed funds of $50,000), or 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.
Why $5,000? Well, 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
So, 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 he only has $10,000 in investor's equity, resulting in a $5,000 deficiency ($60,000 x 25%) - $10,000.