The Basics of Margin Equity and Margin Equity Percentage

Margin equity is the difference between the total market value of an investment account and the outstanding margin loan balance, while margin equity percentage is the ratio of the account's equity to its total market value expressed as a percentage.

Margin trading allows you to borrow funds and increase position sizes in your portfolio. But the leverage used in margin trading comes with an increased risk of capital loss, which is why you need to keep track of your margin equity. As the value of your portfolio changes, you will have to continue monitoring your margin levels. Margin equity and margin equity percentage help you account for your borrowing status.

This article will explore the basics of margin equity and margin equity percentage, including how they are calculated and how they impact your trading strategy. 

What Is Margin Equity?

Margin equity is the difference between the total value of securities held in an investment account and the amount of borrowed funds used to purchase those securities. 

The formula for margin equity is:

Margin Equity = Total Value of Securities - Amount Borrowed

For example, you purchase $15,000 worth of stock on margin by borrowing $5,000 from your broker. The total value of the securities in your account is $15,000 ($10,000 initial investment plus $5,000 borrowed), and the margin equity is $10,000 ($15,000 total value - $5,000 borrowed).

Margin equity reflects the amount of equity in the margin account after accounting for any borrowed funds. It is used to calculate the margin level, which is the percentage of the total value of securities in an account that is not borrowed.

Margin level = (Margin Equity / Total Value of Securities) x 100

The margin level is a margin account risk indicator. A higher margin level indicates that you have more equity in your account and fewer borrowed funds, reducing the risk profile of the account. Conversely, a lower margin level suggests you have less equity and more borrowed funds, making the account riskier. 

Margin Account

A margin account is an investment account that allows you to borrow funds from your broker to purchase securities. Unlike a regular cash account, a margin account allows you to leverage your investments to increase your purchasing power. However, it also exposes you to greater risks, as losses can quickly mount as a result of borrowed funds. Keep in mind that the Financial Industry Regulatory Authority (FINRA) sets an account minimum of $2,000 or 100% of the price of the margin securities, whichever is less. However, brokerage firms can have higher requirements. 

Initial Margin

Initial margin refers to the percentage of the purchase price of a security that an investor must provide as cash when trading with a margin account. Regulation T of the Federal Reserve specifies a minimum initial margin of 50% of a securities' purchase price. The initial margin serves as collateral to help protect against potential losses incurred while trading.

While the initial margin requirement determines how much money you must deposit in the margin account to start trading, the margin equity reflects your actual equity in the account after making trades on margin.

Maintenance Margin

Maintenance margin is the minimum amount of margin equity you must maintain in your margin account to continue holding a position purchased using borrowed funds or leverage.

The maintenance margin is typically set by the broker or exchange and is a percentage of the total value of the securities held in the margin account, but FINRA requires a minimum of 25% of the total market value of the margin securities. Suppose the value of the securities in the account falls below the maintenance margin. In that case, you will receive a margin call from the broker, requiring you to deposit additional funds into the account or sell securities to bring the margin equity back up to the maintenance margin level.

Failure to meet a margin call can result in the broker liquidating positions to cover the outstanding margin debt. 

What Is Margin Equity Percentage?

Margin equity percentage (MEP) is a financial term used to indicate the percentage of equity value in a margin account. It is a crucial metric in margin trading that determines the amount of leverage available to make trades.

The formula for calculating the margin equity percentage is: 

MEP = (Equity / Total Value of Securities) x 100

The higher the MEP, the more leverage you can use. However, increased leverage also means higher risk, as losses can be magnified just as much as potential gains. A lower MEP could indicate an impending margin call.

Say you have $50,000 in equity and hold $100,000 worth of securities in your margin account. To calculate the MEP, divide the equity by the total value of securities, then multiply by 100:

MEP = (50,000 / 100,000) x 100 = 50%

With a margin equity percentage of 50%, you can use up to 50% leverage on trades. For instance, if you wanted to buy $150,000 worth of securities, you could use $50,000 of your equity and borrow $50,000 (50% of the total value of securities) from a broker.

What Is Margin-to-Equity Ratio (ME)?

Margin-to-equity (ME) ratio measures the amount of borrowed funds compared to the equity value in the account. Investors and traders use the ME to assess the risk level of trading activities.

The formula for calculating the margin-to-equity ratio is the following:

ME = Margin / Equity

The ME ratio helps determine the risk level associated with margin trading activities. The higher the margin-to-equity ratio, the more leverage you’re using and the more risk you take. In contrast, a lower margin-to-equity ratio indicates that you are using less leverage and taking on less risk.

Suppose you have $10,000 in equity and want to purchase $30,000 worth of securities in your margin account. The broker requires a margin of $20,000 for this trade. Therefore, the margin-to-equity ratio would be:

ME = Margin / Equity = $20,000 / $10,000 = 2

This means you’re using 2x leverage, or 200% of your equity, to finance the trade. Borrowing this amount of capital involves a high level of risk. By keeping track of the margin-to-equity ratio, you can better adjust your positions and manage risks.

Get to Know Margin Concepts

Margin equity refers to the amount of equity an investor has in a margin account – a type of brokerage account that allows an investor to borrow money to purchase securities. Margin equity percentage, on the other hand, refers to the percentage of the total value of a position that is held in the investor's margin account.

Understanding these two concepts can impact your capital usage and affect your ability to make trades.

Frequently Asked Questions