What is a Margin Call?
A Margin Call occurs when the value of the investor’s margin account drops and fails to meet the account's maintenance margin requirement. An investor will need to sell positions or deposit funds or securities to meet the margin call. If the investor fails to cover the margin call within 3 trading days, Firstrade will have to liquidate their positions to meet the margin call.
Here’s an example of how a Margin Call occurs:
You have $20,000 worth of securities bought using $10,000 borrowed and $10,000 in cash. When the margin requirement is 30% and the value of the securities drop by 40% to $12,000, since the amount you borrowed from your broker stays at $10,000, your own equity becomes $2,000 which is lower than the 30% minimum margin requirement.
$2,000 / $12,000 = 16.6% < 30%
A margin call occurs when the percentage of the equity in the account drops below the maintenance margin requirement.
How much is the margin call?$12,000*30% = $3600 → amount of equity you were required to maintain.$3600 - $2000 = $1600 → You will have a $1,600 margin call.
When a Margin Call occurs, you may either deposit funds or liquidate part of the positions you purchased on margin to cover the margin call.
By depositing funds you decrease the amount of margin and increase your equity. When you deposit $1,600 of cash into your account, your new account balance consists of $3,600 of cash and $8,400 of margin.$3,600/($3,600 + $8,400) = 30% → reached margin requirement.
By selling stocks, you decrease the amount of margin, therefore increase the percentage of the equity.
**Below is the calculation formula: **X = the amount of stocks you should sell to cover the call.[($10,000 - X) + $2,000] * 0.3 = $2,000($12,000 - X) * 0.3 = $2,000$3,600 - 0.3X = $2,000$1,600 = 0.3XX = $1,600/0.3 = $5,333.3 → reached margin requirement.
In general, if you would like to deposit funds, the amount has to be equal to the margin call amount. If you choose to liquidate your stocks to cover the call, the amount you have to sell should be equal to the margin call amount divided by the minimum maintenance requirement.
$1600/30% = $5333.3→ To maintain the 30% minimum margin requirement, you will need to either sell $5,333.3 worth of securities or deposit $1,600 worth of cash within 3 trading days, or Firstrade must liquidate your positions.
How can I avoid a Margin Call?
- Try not to use up your entire Margin Buying Power.
- Avoid a concentrated portfolio by diversifying your positions.
- Avoid trading on margin in highly volatile securities.
- Constantly monitor your account.
As an experienced financial analyst with a deep understanding of margin trading and investment strategies, I have a wealth of knowledge in the field of margin accounts, leveraging securities, and the intricacies of margin calls.
Margin calls are a critical aspect of trading on margin, where an investor borrows funds from a broker to invest in securities. When the value of these securities drops, failing to meet the account's maintenance margin requirement, a margin call is triggered. This demand requires the investor to either deposit additional funds or sell assets to cover the shortfall and restore the required margin level.
Let's break down the concepts mentioned in the article:
-
Margin Account: A type of brokerage account where the investor borrows funds from the broker to purchase securities. It allows investors to leverage their positions, amplifying potential gains or losses.
-
Maintenance Margin Requirement: This is the minimum amount of equity an investor must maintain in a margin account as a percentage of the total value of the securities held in the account. In the provided example, the maintenance margin requirement is set at 30%.
-
Equity and Margin Call Calculation: The equity in a margin account is the difference between the account value and borrowed funds. If the equity falls below the maintenance margin requirement due to a decline in security value, a margin call is issued.
-
Margin Call Amount: Calculated as the difference between the required equity based on the maintenance margin requirement and the actual equity in the account. In the example, it's calculated as $1,600.
-
Covering a Margin Call: Investors can cover a margin call by either depositing additional funds or selling a portion of the securities in their account. This action helps restore the required margin level.
-
Formula for Selling Stocks to Cover a Margin Call: The formula provided in the article calculates the amount of stocks an investor needs to sell to meet the margin call and maintain the minimum margin requirement.
-
Tips to Avoid Margin Calls: Strategies to prevent margin calls include not fully utilizing margin buying power, diversifying investments, avoiding highly volatile securities, and regularly monitoring the account to ensure compliance with margin requirements.
Understanding these concepts is crucial for investors engaging in margin trading. It's essential to manage risks carefully and have a clear strategy to avoid potential margin calls that could lead to forced liquidation of positions.
