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What Is a Margin Call?

A margin call occurs in securities trading when the equity in an investor's brokerage account falls below a specific percentage of the total value of the securities held on margin. This typically happens when the value of the securities purchased with borrowed money (known as leverage) declines. The margin call serves as a demand from the broker for the investor to deposit additional funds or securities to bring the account's equity back up to the required maintenance margin level. Margin calls are a critical component of risk management in the realm of financial leverage.

History and Origin

The concept of borrowing money to invest, or buying on margin, has a long history in financial markets. Its widespread adoption, particularly in the United States, played a significant role in market dynamics leading up to major financial events. During the speculative boom of the 1920s, buying stocks on margin became increasingly popular, allowing investors to control larger positions with a relatively small upfront cash outlay. This amplified gains during the rising market but also magnified losses when prices turned. The substantial amount of money borrowed to purchase securities on margin contributed to the severity of the 1929 stock market crash, as declining stock prices triggered a cascade of margin calls, forcing investors into desperate selling. This feedback loop exacerbated the market's descent, demonstrating the systemic risk associated with widespread margin use.⁴ Following this period, regulations were introduced to control margin lending and mitigate such risks.

Key Takeaways

• A margin call is a demand from a brokerage firm for an investor to deposit additional funds or securities into their margin account.
• It is triggered when the equity in a margin account falls below the required maintenance margin level.
• Failure to meet a margin call can lead to the forced liquidation of assets in the investor's portfolio.
• Margin calls are designed to protect both the broker and the investor by ensuring sufficient collateral for the borrowed funds.
• They highlight the amplified risks inherent in using financial leverage for investment.

Formula and Calculation

A margin call is typically triggered when the actual margin percentage (also known as the equity percentage) falls below the maintenance margin requirement set by the brokerage firm or regulatory bodies.

The Actual Margin Percentage is calculated as:

$\text{Actual Margin Percentage} = \frac{\text{Current Market Value of Securities} - \text{Debit Balance}}{\text{Current Market Value of Securities}}$

Where:

• Current Market Value of Securities is the total market value of the assets held in the margin account.
• Debit Balance is the amount of money the investor has borrowed from the broker.

A Margin Call is triggered when:
$\text{Actual Margin Percentage} < \text{Maintenance Margin Requirement}$

To determine the price at which a margin call will occur for a long position, given a specific maintenance margin percentage (MMR):

$\text{Margin Call Price} = \frac{\text{Debit Balance}}{(\text{Number of Shares} \times (1 - \text{Maintenance Margin Requirement}))}$

For example, if an investor borrowed money to purchase shares, and the value of those shares drops, the debit balance remains constant while the current market value decreases, reducing the actual margin percentage. If this percentage falls below the maintenance margin set by the broker, a margin call is issued.

Interpreting the Margin Call

Receiving a margin call indicates that the market value of the securities in a margin account has declined to a point where the investor's equity no longer meets the minimum required percentage of the total position. This is a crucial signal that the investor's leveraged position is incurring significant losses. The interpretation is straightforward: the broker needs additional collateral to secure the debt that the investor owes.

If the investor fails to meet the margin call, the brokerage firm has the right to sell assets in the account to cover the shortfall. This forced sale, often at unfavorable prices due to market volatility that likely triggered the call, can lock in substantial losses. Therefore, a margin call is an urgent warning requiring immediate action to either deposit more funds or liquidate positions to prevent further, potentially devastating, losses.

Hypothetical Example

Consider an investor who purchases $20,000 worth of stock, using $10,000 of their own capital and borrowing $10,000 from their broker. This means their initial margin is 50%. The brokerage firm has a maintenance margin requirement of 30%.

Initially:

• Current Market Value of Securities = $20,000
• Debit Balance = $10,000
• Equity = $20,000 - $10,000 = $10,000
• Actual Margin Percentage = $10,000 / $20,000 = 50%

Now, imagine the stock price drops. To find the price at which a margin call would be triggered, we can use the formula:

$\text{Margin Call Price} = \frac{\$10,000}{(\text{Number of Shares} \times (1 - 0.30))}$

Let's assume the investor bought 200 shares at $100 each ($20,000 total).
$\text{Margin Call Price} = \frac{\$10,000}{(200 \times (1 - 0.30))} = \frac{\$10,000}{(200 \times 0.70)} = \frac{\$10,000}{\$140} \approx \$71.43 \text{ per share}$

If the stock price falls to $71.43 per share:

• New Current Market Value of Securities = 200 shares * $71.43/share = $14,286
• Debit Balance = $10,000 (remains unchanged)
• New Equity = $14,286 - $10,000 = $4,286
• New Actual Margin Percentage = $4,286 / $14,286 \approx 30%

At this point, the actual margin percentage has hit the maintenance margin requirement of 30%, triggering a margin call. The investor must now deposit funds to bring the equity back to the initial margin level or above the maintenance margin. For instance, if the broker requires the equity to be 30% of the new market value, the required equity would be 30% of $14,286 = $4,285.80. The investor only has $4,286, so a call may be issued to restore a buffer, or if the percentage dipped slightly below 30%.

Practical Applications

Margin calls are a core component of securities trading, particularly for investors employing leverage. They are practically applied by brokerage firms to manage credit risk. Brokers use margin requirements, which are governed by regulations like the Federal Reserve Board's Regulation T and rules set by self-regulatory organizations like FINRA, to control the amount of money investors can borrow.³

In real-world scenarios, margin calls frequently arise during periods of significant market volatility or broad market downturns. For example, during the initial phases of the COVID-19 pandemic, global stock markets experienced rapid and substantial declines, leading to a surge in margin calls as asset values plummeted. This created a "contagious" effect, impacting market liquidity as investors were forced to sell.² The level of margin debt in the market is also closely monitored as a gauge of investor sentiment and potential systemic risk, with organizations like FINRA publishing regular reports on total investor margin debt.¹

Limitations and Criticisms

While margin calls serve as a crucial risk control mechanism, they are not without limitations and criticisms. A primary concern is that they can exacerbate market downturns. When a large number of investors receive margin calls simultaneously, it can lead to a wave of forced selling, driving prices down further and triggering more margin calls, creating a "fire sale" effect. This procyclicality can amplify market volatility and contribute to systemic instability.

Another criticism is the potential for investors to face significant, rapid losses. The use of leverage means that a small percentage decline in asset value can lead to a much larger percentage loss of the investor's capital. In extreme cases, investors can lose more than their initial investment if the value of their securities falls below the debt owed, leading to negative equity. Furthermore, the timing of a margin call can be unexpected, requiring immediate action, which can be stressful and lead to emotional, potentially suboptimal, trading decisions. While regulations exist, brokerage firms also have "house" margin requirements that can be more stringent, adding another layer of complexity and potential for unexpected calls.

Margin Call vs. Short Squeeze

While both a margin call and a short squeeze involve forced actions in trading, they are distinct phenomena with different triggers and primary directions of price movement.

While a margin call can occur on a short position if the stock price rises significantly, making the value of the borrowed shares (and thus the potential loss) too high relative to the collateral, the term "short squeeze" specifically refers to the rapid price appreciation caused by short sellers buying to cover.

FAQs

What happens if I get a margin call and don't have the money?

If an investor receives a margin call and cannot deposit the required funds or additional securities, the brokerage firm has the right to sell assets in the account to cover the shortfall. This forced liquidation occurs without the investor's consent and often at unfavorable market prices, potentially leading to significant realized losses.

How much notice do I get for a margin call?

The amount of notice for a margin call can vary. While some brokers may offer a few days' notice, especially for smaller calls, they are legally permitted to demand immediate action. Crucially, a broker can sell an investor's securities without prior notification if market conditions rapidly deteriorate or if the investor fails to meet the call promptly. It is the investor's responsibility to monitor their brokerage account closely.

Can a margin call be avoided?

While a margin call cannot be entirely eliminated when trading on margin, its likelihood can be reduced by maintaining a higher cash or equity balance in the account than the minimum requirements. Employing less leverage than the maximum allowed, diversifying a portfolio, and actively managing risk by setting stop-loss orders can also help mitigate the risk of a margin call.