Trading on margin offers a variety of potential benefits, such as the ability to borrow money from your broker to buy securities. While margin trading can increase your returns, you are also exposing yourself to risk. A margin call can increase the probability of your losses and possible liquidation of your account. In this article, we take a look at how to avoid margin calls.
What Is a Margin Call?
When a trader receives notification from his broker that the money in their trading account is insufficient to maintain an open position, this is referred to as a margin call or maintenance call. A margin call may force the trader to exit positions to lower the needed maintenance margin or provide extra cash to balance the account.
3 Types of Margin Calls
There are three types of margin calls a trader can get. Take a look at what they are.
1. Federal (Initial) Call
Also known as initial calls, this type of margin call occurs when an investor cannot meet the minimum margin requirement for a purchase as stipulated by Regulation T. This provision states that an investor may borrow up to 50% of the purchase price of securities using a loan from a broker-dealer. The remaining 50% of the price must be funded with cash. When the amount in the trading account falls below 50%, the trader receives a federal call.
2. Maintenance (House) Call
This margin call occurs when the value of an investor’s account equity drops below a specified minimum percentage of the account value. For example, if a broker demands a maintenance margin of 25%, this means the minimum equity amount in the margin account must be valued at 25% or more.
3. Exchange Call
Also known as a house or brokerage call, this margin call occurs when account equity drops below a minimum percentage of the account's value. House calls are sensitive to market volatility because the maintenance requirement is based on the shares’ market value and not the purchase price. When a margin call is placed, the trader is expected to fund the account to cover margin shortfalls within two to five business days or your account positions may be partially or fully liquidated to cover the margin loan.
What to Do After a Margin Call
When you get a margin call, there are several things you should do to prevent your account positions from being partially or fully liquidated. Here's a rundown of what you can do when you get the dreaded call from your broker.
1. Deposit Cash
Funding your margin account is your first option when you get a margin call from your broker. The amount you would deposit depends on the margin shortfall. It is always advisable to have this money handy before you start margin trading, and always deposit above the minimum maintenance. For example, if your maintenance margin is 25%, it is a good strategy to have 50%.
2. Deposit Securities
You can choose to deposit fully paid-for shares of stock as additional collateral for your margin loan. To determine how many shares would be necessary to meet a $5,000 margin call, divide $5,000 by the difference between the loan value and maintenance requirement of the stock you plan to deposit.
For example, if the maintenance requirement is 30%, then you divide $5,000 by 70%, which is the difference between loan value (100%) - maintenance requirement (30%). This would give you $7,142.85, which is the amount of stock you would have to deposit to cover a $5,000 margin call.
3. Liquidate Stock
You can liquidate stock in your account to raise money to meet the maintenance requirements. You can calculate this amount by multiplying the value of the stock sold by the maintenance requirement for the shares that remain in your margin account. Still using the 30% maintenance requirement, you would sell $16,675 worth of stock to meet your $5,000 margin call.
Practical Example of a Margin Call
| Security value | Loan amount | Equity | Equity (%) | |
| $10,000 | $5,000 | $5,000 | 50% | |
| Value drops to | $7,000 | $5,000 | $2,000 | 28% |
| Maintenance requirement | $7,000 | $2,100 | 30% | |
| Margin call | $100 |
The table above shows a particle example of how a margin call works. In the scenario, you either deposit $100 cash into your account or sell securities worth $142.85 i.e. $100 / (100% - 30%) to satisfy the margin call. If you are unable to satisfy the margin call after two to five business days, your positions may be sold to cover the margin deficiency.
How to Avoid a Margin Call
The stress of margin calls can have significant financial repercussions. Your brokerage may decide to liquidate your stocks without informing you or considering the tax implications. As a result, if you want to avoid margin calls, it is important to take certain factors into account to reduce the likelihood of receiving a margin call:
- Have enough cash: Keep a sizeable cash reserve in your account as backup against a sharp decline in the value of your loan collateral.
- Decide on a personal trigger: If you need to add funds or securities to your margin account, have extra liquid resources on hand.
- Monitor your account closely: Keep an eye on your account every day, and set up alerts to let you know when the value of your stock starts to decline sharply.
- Set your own maintenance margin: Do not depend on your broker's maintenance margin. Set yours above theirs. This would help you move resources into your account before you get a margin call.
- Use a margin calculator: You can always use a margin calculator to know what amounts would be sufficient to meet your maintenance requirement. Keep in mind the value of securities fluctuates daily and so do the requirements too.
Watch for a Margin Call
Leverage can be a powerful thing as it allows you to aim for bigger profits than you otherwise could with your capital. However, it also comes with the risk of bigger losses.
To prevent a margin call, you have to pay greater attention to reducing risk than making a profit. This entails constantly monitoring your account, setting a higher maintenance requirement and depositing far above the minimum amount required in your margin account.
Frequently Asked Questions
What is meant by a margin call?
A margin call is an instruction from your broker to increase the amount of equity in your account.
What happens if you don't answer a margin call?
Depending on the size of your margin loan, your account positions can be partially or fully liquidated after two to five business days if you fail to answer a margin call.
What happens when the margin level hits zero?
When the margin level hits zero, your account should not have any open positions on margin.
About Anna Yen
Anna Yen, CFA is an investment writer with over two decades of professional finance and writing experience in roles within JPMorgan and UBS derivatives, asset management, crypto, and Family Money Map. She specializes in writing about investment topics ranging from traditional asset classes and derivatives to alternatives like cryptocurrency and real estate. Her work has been published on sites like Quicken and the crypto exchange Bybit.