What is a Margin Call?

A margin call happens when the investor’s equity percentage in a margin account drops below the broker's required level. This account includes securities purchased using both the investor’s money and funds borrowed from the broker.

Specifically, a margin call is a demand from the broker for the investor to add more money or securities to the account, ensuring the investor's equity meets the minimum required by the maintenance rule.

Typically, a margin call indicates a decline in the value of the securities in the margin account. When this occurs, the investor must either add more funds or marginable securities to the account or sell some assets within the account to satisfy the margin call.

What Triggers a Margin Call?

When an investor buys on margin, they use a combination of their own funds and money borrowed from a broker to buy and sell securities. The investor’s equity in the investment is the market value of the securities minus the borrowed amount.

*A margin call is triggered when the investor’s equity percentage falls below the required maintenance margin level.

The New York Stock Exchange (NYSE) and the Financial Industry Regulatory Authority (FINRA), which oversees most U.S. securities firms, mandate that investors maintain at least 25% equity of the total value of their securities when buying on margin.

Some brokerage firms may have higher maintenance requirements, ranging from 30% to 40%.

Margin calls can occur at any time due to a decline in account value, but they are more likely during periods of market volatility.

How to Cover a Margin Call

When a margin call is issued, the investor typically has two to five days to take action. Here are the options to cover the margin call:

1. Deposit $200 in cash into the account.
2. Deposit $285 worth of fully paid-for marginable securities into the account. This is calculated by dividing the required $200 by 1 minus the 30% equity requirement: 200/(1-0.30) = $285.
3. Use a combination of cash and securities to cover the margin call.
4. Sell other securities to obtain the necessary cash.

If the investor fails to meet the margin call, the broker may close out open positions to restore the account to the minimum required value, potentially without the investor’s approval. The broker may also charge a commission for these transactions, and the investor is responsible for any losses incurred during the process.

*The amount of a margin loan is based on the security's purchase price and remains fixed. However, the maintenance margin requirement is based on the current account value, causing it to fluctuate.

How to Avoid a Margin Call

Investors should carefully consider whether they need a margin account, as most long-term investors don't need to buy on margin to achieve solid returns, and these loans incur interest charges.

If you choose to invest with margin, here are some strategies to manage your account and avoid a margin call:

1. Ensure you have cash available to deposit into your account immediately, possibly keeping it in an interest-earning account at the same brokerage.

2. Build a diversified portfolio to help limit margin calls, as it reduces the likelihood that a single position will significantly decrease your account value.

3. Regularly monitor your open positions, equity, and margin loans, ideally on a daily basis.

4. Set custom alerts at a level above the margin maintenance requirement. If your account value approaches this level, deposit funds or securities to increase your equity.

5. Address any margin calls immediately if they occur.

Additionally, using protective stop orders can help limit losses on equity positions, which, along with maintaining adequate cash and securities in your account, can further help avoid margin calls.

Is It Risky to Trade Stocks on Margin?

Trading stocks on margin is riskier than trading without it because it involves using borrowed money. Leveraged trades inherently carry more risk than unleveraged ones. The primary danger of margin trading is that investors can lose more than their initial investment.

How Can a Margin Call Be Met?

A margin call occurs when there's a margin deficiency in the trader’s account, prompting the broker to issue the call. The trader must either deposit cash or marginable securities into the margin account or sell some securities in the account to address the margin deficiency.

Can a Trader Delay Meeting a Margin Call?

A margin call must be met immediately. While some brokers may allow two to five days to address the margin call, the terms of a standard margin account agreement usually give the broker the right to liquidate any securities or assets in the margin account at their discretion and without prior notice.

To avoid forced liquidation, it is best to promptly meet a margin call and rectify the margin deficiency.

How Can I Manage the Risks Associated With Trading on Margin?

To manage the risks associated with trading on margin, consider the following measures:

1. Use stop-loss orders to limit potential losses.

2. Keep leverage at manageable levels.

3. Borrow against a diversified portfolio to reduce the likelihood of a margin call, as it is more probable with a single stock.

Does the Total Level of Margin Debt Impact Market Volatility?

High levels of margin debt can increase market volatility. During significant market declines, clients are forced to sell stocks to meet margin calls, creating a vicious cycle where intense selling pressure lowers stock prices further, leading to more margin calls and additional selling.

The Bottom Line

Buying on margin isn't suitable for everyone. Not all investors have the available funds to meet initial and maintenance margin requirements. While margin trading can amplify returns, it also comes with significant downsides.

The advantage of margin trading only materializes if your securities appreciate enough to cover the margin loan and its interest. Margin calls are another potential issue, requiring investors to deposit additional cash or securities, sell existing holdings, or close out the margined position at a loss. Margin calls often occur during volatile markets, potentially forcing sales at lower-than-expected prices.