Last updated on April 11th, 2024 at 12:46 am
In this article, we’ll study about What is a margin call.
If you are an experienced trader, or want to learn about trading, you should know about What is a margin call. It’s a trading term which is used in Marginal trading.
The people who are interested in trading but don’t have enough funds to trade, or people who want to trade in big bucks and can’t afford it, these types of traders opt for Marginal trading.
Even new traders who are just trying to dip their toe in the world of trading opt for marginal trading due to the low investment.
Before we learn about What is a margin call? I want to make sure you know about Margin trading.
What is Margin Trading?
Margin trading is a form of trading where the investor borrows capital from a broker or a brokerage firm and trades with that borrowed money. In exchange for lending the capital to the investor, the broker or the firm charges interest on the borrowed capital.
Now that you know the basics of Margin Trading, let’s see What is a margin call.
Along with What is a Margin Call? ALSO READ : What is Margin in Trading? 3 Important types of Margin in Trading you should know as an Investor
What is a Margin Call?
Meaning
When you work in marginal trading, after establishing the margin account, there are certain requirements that are to be completed i.e the Initial margin and the maintenance margin. It is to make sure the account holder maintains the minimum required balance in the account.
When the account holder fails to maintain the minimum balance, then the firm or the broker who lends the capital to the account holder have to make the margin call.
The margin call is to inform the account holder to replenish their account and maintain the minimum balance. After the margin call, the account holder is given a limited period of time to replenish the account.
If the account holder fails to maintain minimum balance even after the margin call, the broker or the brokerage firm who lent the capital have the right to sell some of the investments of the account holder till minimum balance is restored into the account.
Definition
Margin Call can be defined as a warning call for the marginal account holder/ Investor when their account balance falls below the minimum balance requirement.
The margin call price i.e. the minimum balance requirement price is calculated by the following formula,
The Margin Call price = Initial Purchase price of the security x 1 – initial Margin/ 1 – Maintenance Margin
Example of Margin Call
| Security Value | Borrowed Capital | Owner’s Capital | Owner’s Capital in % | |
| Bought security for $10,000 | $ 10,000 | $ 6,000 | $ 4,000 | 40% |
| Fallen Price of security | $ 8,000 | $ 6,000 | $ 2,000 | 20% |
| Maintenance requirement | $ 8,000 | $ 3,000 | 30% | |
| Margin call Value | $ 1,000 |
In the above example, the value of security is $10,000 where $6,000 is borrowed capital and $4,000 is investors own capital. The maintenance margin given is 30% i.e. 30% of $10,000, which is $3,000.
When the price of the security falls to $8,000, the investors capital falls down to $2,000 which is less than the minimum required balance, this is when the broker or the brokerage firm gives a margin call to the investor.
Now, I’m sure the example made it clear about What is a Margin Call and when the broker does a margin call. Now, let’s see what are the ways to replenish after a margin call.
Along with What is a Margin Call? ALSO READ : Agency Trading vs Principal Trading : 2 Important Difference
How to cover a Margin call
When an investor receives a margin call, they have a limited period of time to replenish their margin account, usually a few days from 3-7 days. Below are the ways the investor can replenish their margin accounts.
- The investor can deposit the required amount of capital to maintain the minimum amount requirement for the account. For the above example, depositing $1,000 into the account within the time frame.
- The investor can liquidity their current securities to pay up and fulfill the accounts minimum requirement.
- The investor can deposit extra sum, more than the needed amount into the account and have a safety deposit in the account.
- If the investor fails to pay the required amount in time, the Broker or The Brokerage firm can liquidity the investors securities and cover up for the accounts minimum requirement.
How to steer clear of Margin call
You are aware about What is a Margin Call and how to cover up margin calls, but I believe that prevention is always better than cure. That’s why, here are a few hints and advice to avoid margin calls.
- Check for regular updates on your account, the securities you’ve invested in, check whether there is profit or loss to be prepared in advance for your future move.
- The most important advice is to set a limit on yourself. Know how much you want to invest, how much the fall in price can be handled, how much profit you want, and when you reach that limit, don’t be greedy and pull out. This is the smartest way for any investor.
- Always have Backup capital to replenish the account in case of loss.
- Make a diversified portfolio in the same brokerage firm. It reduces the risk in case of an unpredicted situation.
Along with What is a Margin Call? ALSO READ : Financial rights to the Assets of a Business
FAQs
What happens if you get a margin call?
If you receive a margin call it means that the capital in your trading account has fallen below the minimum required capital for the account you agreed upon. So, the Margin call is to inform you about this and provide you a time period to pay and replenish the account.
What is margin call 50%?
When your owned capital falls below 50% of the minimum required capital, its called Margin Call 50%.
What is opposite of margin call?
When you reserve collateral appreciates in value, you can ask for some collateral back which becomes surplus for the agreed upon collateral. This process is called Reverse Margin call.
Closing Statement
Margin trading is a helpful way of trading for people with low funds and high market knowledge. It carries high risk as well as high rewards. But if some loss occurs in the price of the security, you can use the formula for marginal call price to know how much capital has to be paid into the account to maintain the balance.
I hope this article about,”What is a Margin Call?” Was helpful and informative to you. I believe you have the knowledge about What is a Margin Call, how it works and how to pay if the situation ever arises.
If there are any questions or recommendations, call it up in the comment box.
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