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Margin call

What Is a Margin Call?

A margin call is a demand from a brokerage firm for an investor to deposit additional funds or securities into their margin account. This demand arises when the equity in the account falls below a specified minimum level, known as the maintenance margin, usually due to a decline in the value of the securities held. Essentially, it is a notice that the investor's collateral for a loan is no longer sufficient, and they must either add more capital or sell off existing securities to reduce the loan amount. The concept of a margin call is a critical component of securities trading, particularly for those who utilize leverage.

History and Origin

The concept of margin trading, and consequently the margin call, has roots in the early days of stock markets, allowing investors to purchase more shares than they could afford outright by borrowing against their existing holdings. This practice gained widespread prominence and became a significant factor leading up to the Stock Market Crash of 1929. During the speculative boom of the "Roaring Twenties," many individuals and institutions engaged in extensive speculation by buying stocks on margin, often putting down as little as 10% of the stock's price30.

When the market began to turn in October 1929, the widespread use of margin amplified the downturn. As stock prices plummeted, brokerage firms issued a cascade of margin calls, demanding immediate payment from investors. Many investors were unable to meet these calls, forcing them to liquidate their holdings at depressed prices, which further accelerated the market's decline. This massive wave of forced selling contributed significantly to the severity of the crash and the ensuing economic fallout, highlighting the systemic risks associated with unchecked leverage in financial markets28, 29. The aftermath of this financial crisis led to the establishment of regulatory bodies and rules, such as Regulation T by the Federal Reserve, to govern margin requirements and mitigate future systemic risks.

Key Takeaways

  • A margin call is a demand from a brokerage firm for an investor to add funds or liquidate assets in their margin account.
  • It occurs when the account's equity falls below the regulated or firm-specific maintenance margin requirement.
  • Failure to meet a margin call can result in the forced liquidation of securities by the brokerage, often at a loss.
  • Margin calls highlight the amplified risks associated with using borrowed money (leverage) to invest.
  • Regulatory bodies, such as the Federal Reserve and FINRA, establish rules to govern margin accounts and their requirements.

Formula and Calculation

A margin call is typically triggered when the equity in a margin account falls below a certain percentage of the securities' current market value, as dictated by the maintenance margin requirement. While the specific threshold varies by brokerage and regulatory body (FINRA's minimum is 25%, but firms often set higher), the core principle remains consistent.

The equity in a margin account is calculated as:
Equity=Market Value of Securities−Loan Amount\text{Equity} = \text{Market Value of Securities} - \text{Loan Amount}

A margin call is issued when:
EquityMarket Value of Securities<Maintenance Margin Requirement\frac{\text{Equity}}{\text{Market Value of Securities}} < \text{Maintenance Margin Requirement}

To determine the price at which a margin call will occur for a long position, you can rearrange the formula:

Margin Call Price=Loan AmountNumber of Shares×(1−Maintenance Margin Requirement)\text{Margin Call Price} = \frac{\text{Loan Amount}}{\text{Number of Shares} \times (1 - \text{Maintenance Margin Requirement})}

Or, more simply, if you know the initial purchase price and initial margin percentage, and assuming a 50% initial margin and 25% maintenance margin:

Margin Call Price=Initial Purchase Price×(1−Initial Margin Percentage)(1−Maintenance Margin Requirement)\text{Margin Call Price} = \text{Initial Purchase Price} \times \frac{(1 - \text{Initial Margin Percentage})}{(1 - \text{Maintenance Margin Requirement})}

Where:

  • Equity represents the investor's ownership stake in the account.
  • Market Value of Securities is the current total value of all securities held in the margin account.
  • Loan Amount is the outstanding debt owed to the brokerage firm.
  • Maintenance Margin Requirement is the minimum percentage of equity that must be maintained in the account, expressed as a decimal.

Interpreting the Margin Call

Receiving a margin call is a clear indicator that the value of an investor's portfolio purchased on margin has declined significantly, eroding the buffer against potential losses. It signals that the collateral backing the broker's loan is insufficient to meet the agreed-upon maintenance requirements. For the investor, it means that they are now facing a heightened level of risk, as continued declines could lead to further losses, potentially exceeding their initial investment27.

The issuance of a margin call requires immediate action. The investor must either deposit additional cash or marginable securities to bring the account's equity back to the required level, or face the forced liquidation of their holdings by the brokerage. The margin call serves as a critical risk management mechanism for brokerage firms, protecting them from loan defaults, but it places the burden and consequences of adverse price movements squarely on the investor.

Hypothetical Example

Consider an investor who purchases 1,000 shares of XYZ stock at $50 per share, totaling $50,000. They use a margin account with an initial margin requirement of 50%, meaning they put down $25,000 of their own capital and borrow $25,000 from their brokerage firm. The brokerage's maintenance margin requirement is 30%.

  1. Initial Purchase:

    • Market Value = $50,000
    • Loan Amount = $25,000
    • Equity = $25,000
    • Equity % = ($25,000 / $50,000) = 50%

  2. Stock Price Drops: Suppose XYZ stock drops to $35 per share.

    • New Market Value = 1,000 shares * $35 = $35,000
    • Loan Amount (remains constant) = $25,000
    • New Equity = $35,000 - $25,000 = $10,000
    • New Equity % = ($10,000 / $35,000) = 28.57%

Since the new equity percentage (28.57%) is below the brokerage's 30% maintenance margin requirement, the investor receives a margin call. To meet this margin call, the investor needs to increase their equity to at least 30% of the current market value ($35,000 * 0.30 = $10,500). This means they must deposit an additional $500 ($10,500 - $10,000) in cash or marginable assets into their account. If they fail to do so, the brokerage can sell some or all of their XYZ shares to cover the deficiency.

Practical Applications

Margin calls are a fundamental aspect of operating a margin account and apply across various segments of securities trading. For individual investors and institutional traders alike, understanding margin calls is crucial for effective risk management. They show up in common investment scenarios, from buying stocks on margin to engaging in more complex strategies involving derivatives or short selling.

Regulatory bodies play a significant role in establishing the framework for margin requirements, which directly influence when a margin call might occur. In the United States, the Federal Reserve Board's Regulation T sets the initial margin requirement, typically at 50% for most equity securities24, 25, 26. FINRA (Financial Industry Regulatory Authority) then sets minimum maintenance margin requirements, generally at 25% of the total market value of securities22, 23. Brokerage firms often impose stricter "house" requirements, which are higher than the regulatory minimums, to provide an additional buffer against market volatility.

For investors engaged in day trading, specific and often more stringent margin rules apply, including minimum equity requirements and restricted buying power if margin calls are not met within a short timeframe20, 21. These rules underscore the regulatory focus on managing systemic risk and protecting investors from excessive leverage. Investors can learn more about margin accounts and their associated risks from resources provided by the Securities and Exchange Commission (SEC).19

Limitations and Criticisms

While intended as a risk management tool for brokerage firms, margin calls can pose significant challenges and risks for investors. A primary criticism is that they can lead to amplified losses, potentially causing an investor to lose more than their initial investment. When a margin call is issued, an investor's options are limited: either deposit more cash or securities, or face forced liquidation of their holdings17, 18. This forced selling often occurs at unfavorable prices, crystallizing losses and removing the opportunity for the investor to recover if the market subsequently rebounds16.

Furthermore, brokerage firms typically have the right to sell an investor's securities to meet a margin call without prior notice, and they are not obligated to sell the securities that would result in the least financial impact to the investor14, 15. This can be particularly detrimental in rapidly declining markets, where quick action by the brokerage to protect its loan can severely impact the investor's portfolio. The risks associated with margin trading, including the potential for significant losses from a margin call, are highlighted in investor alerts from organizations like FINRA. [https://www.finra.org/investors/alerts/investing-borrowed-funds-no-margin-error]

Some economic studies have also debated the effectiveness of margin requirements as a tool to control market volatility and prevent excessive speculation. While some research has suggested an inverse relationship between margin levels and stock price volatility, other analyses have found less conclusive evidence, indicating that factors beyond margin requirements may play a more dominant role in market fluctuations.13 Regardless of the broader economic debate, for the individual investor, the threat of a margin call represents a substantial and immediate financial hazard.

Margin Call vs. Maintenance Margin

The terms "margin call" and "maintenance margin" are closely related but refer to distinct concepts in securities trading. The maintenance margin is a regulatory or brokerage-specific requirement that dictates the minimum percentage of equity an investor must maintain in their margin account relative to the total market value of the securities held12. It acts as a safety threshold to ensure that the investor's collateral for the borrowed funds remains adequate. FINRA, for example, sets this minimum at 25%, though many brokerage firms set higher "house" requirements, often between 30% and 40%10, 11.

A margin call, on the other hand, is the actual notification or demand issued by a brokerage firm to an investor when the account's equity falls below this predetermined maintenance margin level9. It is the consequence of failing to uphold the maintenance margin requirement. While maintenance margin is a static percentage rule, a margin call is the dynamic event that occurs when that rule is violated, triggering specific actions required from the investor to rectify the deficiency.

FAQs

What happens if I receive a margin call and cannot meet it?

If an investor cannot meet a margin call by depositing additional funds or securities, the brokerage firm has the right to sell (liquidate) some or all of the securities in the margin account to cover the deficit8. This forced liquidation occurs without requiring prior permission from the investor and can result in significant losses, potentially even exceeding the investor's initial investment7. The investor remains responsible for any shortfall after the liquidation.

How much time do I have to meet a margin call?

The timeframe to meet a margin call can be very short, often a matter of days (typically two to five business days)6. However, in volatile markets, or if the account falls significantly below the maintenance margin, the brokerage firm may require immediate action or liquidate positions without delay to protect its loan5. It is crucial for investors using margin to monitor their accounts closely and understand their brokerage's specific policies.

Can I avoid a margin call?

While it's impossible to guarantee avoiding a margin call when trading on margin, several strategies can reduce the likelihood. These include maintaining substantial equity above the maintenance margin requirement, selecting less volatile securities, and carefully managing position size. Actively monitoring the market and your portfolio management can help anticipate and potentially prevent a margin call. Some investors choose to avoid margin entirely by only trading in a cash account, where no funds are borrowed.

Does a margin call apply to all types of investments?

A margin call primarily applies to securities purchased in a margin account, where funds are borrowed from a brokerage firm using the investments as collateral. This includes stocks, bonds, and some derivatives. However, not all securities are marginable, and rules can vary significantly for different asset classes like options or futures2, 3, 4. Cash accounts, where an investor uses only their own funds, are not subject to margin calls1.