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: Managing Risks
  7. Margin Trading: Conclusion

As the concepts of maintenance margin and margin call are vital to understanding how a margin account works, we demonstrate these with an example below.

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 Regulation T, you borrow 50% of the purchase price. Assume that the maintenance margin requirement (MMR) is 30%.  (Related: What happens if I cannot pay a margin call? and Do you have to sell your stocks when you get a margin call?)

The Table below shows the changes in the margin account as the stock price fluctuates over time. Note that as the current stock price falls below the purchase price, account equity gets steadily eroded, culminating in a margin call when the shares are trading at $35.

What is the exact stock price below which a margin call will be triggered? This occurs when Account Equity equals the Maintenance Margin Requirement. Mathematically this translates into the stock price at which:

Account Value = (Margin Loan) / (1-MMR)  

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.

When the price of the stock that was purchased at $50 falls to $35, it triggers a margin call of $100. You therefore have one of three choices to rectify your margin deficiency of $100:

  1. Deposit $100 cash in your margin account, or
  2. Deposit marginable securities worth $142.86 in your margin account, which will bring your account value back up to $7,142.86, or
  3. Liquidate stock worth $333.33; with the proceeds used to reduce the margin loan; at the current market price of $35, this works out to 9.52 shares, rounded off to 10 shares.

The value of shares to be liquidated can be calculated by the following relationship:

Liquidation Value = Account Value – (Account Equity / MMR)

Thus, Liquidation Value in this case is: $7,000 – ($2,000 / 0.30) = $333.33

When the stock price falls to $30, the margin deficiency increases to $800. The choices you have to meet your margin call are:

  1. Deposit $800 cash in your margin account, or
  2. Deposit marginable securities worth $1,142.86 in your margin account, which will bring your account value back up to $7,142.86, or
  3. Liquidate stock worth $2,666.67; with the proceeds used to reduce the margin loan; at the current market price of $30, this works out to 88.89 shares, rounded off to 89 shares.

Example of Maintenance Margin and Margin Call

*MMR = Maintenance Margin Requirement

If for some reason, you are not aware of the margin call or cannot meet the margin call, your broker has the right to liquidate stock in the amounts shown without further notice to you.

 


Margin Trading: The Advantages
Related Articles
  1. Trading

    Margin Trading

    Find out what margin is, how margin calls work, the advantages of leverage and why using margin can be risky.
  2. Investing

    Finding Your Margin Investment Sweet Spot

    Borrowing to increase profits isn't for the faint of heart, but margin trading can mean big returns.
  3. Investing

    Stock Market's New Threat Is Record Margin Debt

    Margin debt is a rapidly expanding threat that could turn a modest market drop into a drastic plunge.
  4. Insights

    Do Declining Corporate Margins Point To Recession in 2016?

    Learn how declining profit margins have foretold nearly every recession of the past 50 years, and analyze whether they may signal economic contraction in 2016.
  5. Investing

    How to Trade Futures Contracts

    Futures is short for Futures Contracts, which are contracts between a buyer and seller of an asset who agree to exchange goods and money at a future date, but at a price and quantity determined ...
  6. Insights

    Margin Debt: Will This Indicator Thwack the Market Again?

    In 1999-2000 and 2006-2007, investors' margin debt spiked, then faltered, then the market crashed. Is history about to repeat itself?
  7. Investing

    Buffett Warns Investors To Avoid Borrowing Money To Buy Stocks

    Buffett agrees that soaring margin debt poses big risks to investors
  8. Investing

    Profitability Indicator Ratios

    Learn about profit margin analysis, effective tax rate, return on assets, return on equity and return on capital employed.
Trading Center