Definition
A margin call is a broker’s demand on an investor using margin to deposit additional money or securities so that the margin account is brought up to the minimum maintenance margin. This typically arises if the investor’s account value has fallen below the broker’s required amount. If the investor is unable to meet the margin call, the broker may sell the securities without notification.
Key Takeaways
- A margin call occurs when the value of an investor’s margin account falls below the broker’s required amount. It can happen when the market moves against the investor’s open positions in investments bought with borrowed money.
- When a margin call occurs, the investor is required to either deposit more money into the account or sell off some of the assets held in the account. This is done to bring the account back up to the minimum required value, known as the maintenance margin.
- Not meeting a margin call can result in the broker selling the securities in the account to cover the margin deficiency. This could potentially lead to substantial financial loss for the investor if the securities are sold at a lower price than what they were purchased for.
Importance
A margin call is a crucial term in finance as it’s associated with the practice of buying stocks with borrowed money, or trading on margin.
When an investor’s equity in a margin account sinks below the required level, a margin call occurs, demanding the investor to either deposit additional assets or sell some of their holdings to repay the loans.
It’s critically important because it’s a risk indicator that the investor isn’t meeting their obligations.
If the investor is unable to meet the margin call, the brokerage has the right to sell the assets without waiting for the investor’s approval.
Understanding this helps one avoid potentially major financial losses and impacts their investment strategy.
Explanation
A “Margin Call” is an important tool used in the realm of stock market trading which is primarily designed to protect both brokers and investors from possible substantial losses. It is essentially a risk management strategy used by brokerage firms to maintain a balanced marketplace and ensure that investors are able to cover their losses.
When trading on margin, investors borrow funds from their broker to invest in stocks, amplifying both potential gains and losses. When the assets held as collateral by the broker depreciate in value to a certain threshold, the broker issues a margin call, asking the investor to replenish their margin account.
Issuing a margin call serves the purpose of bringing the investor’s margin account back up to the minimum maintenance margin limit, thereby reducing the risk of the investment for the broker. In the event that the investor cannot meet the margin call, the broker has the right to sell off the investor’s assets without their consent to make up for the deficit.
The margin call is thus used as a kind of insurance policy by the brokers to protect themselves against high-risk investments and insolvency of investors. It acts as a warning sign for investors, urging them to either infuse more money into their margin account or close out their positions, and hence, helps in mitigating their potential losses.
Examples of Margin Call
Long-Term Capital Management Crisis: Long-Term Capital Management (LTCM) was a hedge fund that faced a massive margin call in
LTCM had made large bets on various financial markets using a high amount of leverage. When Russia defaulted on its domestic debt and devalued its currency, LTCM’s complex financial models failed, forcing their brokers to issue margin calls. The fund could not meet the margin requirements, which led to a crisis that threatened to destabilize the global financial system.
Financial Crisis of 2008: During the financial crisis of 2008, many investors and financial institutions faced margin calls due to the sharp decline in the value of mortgage-backed securities and other assets. Financial institutions such as Lehman Brothers, AIG, and Bear Stearns faced insurmountable margin calls that either led to their bankruptcy or pushed them to the brink of it.
Trading Apps Margin Call: In recent times, with the rise of individual day-trading, investors who use trading platforms such as Robinhood might face a margin call if their account falls below the minimum required balance. For instance, if an individual investor is trading on margin and the value of their investment falls significantly, the brokerage can issue a margin call, requiring the investor to either deposit more money into their account or sell off some of their assets to meet the minimum requirement. A high-profile example is the case of Roaring Kitty, who faced a margin call on his GameStop investment during the January 2021 short squeeze.
FAQs on Margin Call
What is a Margin Call?
A margin call is a broker’s demand to a client for bringing margin deposits up to the initial margin level in order to secure the trades that the client has made. It may occur when the value of the account’s securities falls below the required amount.
How is Margin Call calculated?
Margin Call is calculated using the formula: Margin Call = (Account Value – Margin Requirement) ÷ Security Value. This formula calculates how much money is left after the required margin has been subtracted from the total value of the securities.
What happens during a Margin Call?
During a margin call, you must either add additional funds to your account or sell some of your assets. Brokers can sell assets without the client’s approval in a situation of a margin call.
Can you avoid Margin Calls?
It’s possible to avoid margin calls by closely monitoring your account, keeping extra cash in your account, limiting the amount you borrow, and setting a stop order on your trades.
What is the difference between a Margin Call and a Stop Out?
Both margin call and stop out are methods used by brokers to prevent further losses for the trader and for them. A margin call is a warning that the margin level is too low, whereas stop out is the point when the broker starts closing the trader’s positions.
Related Entrepreneurship Terms
- Brokerage Firm
- Margin Requirement
- Equity
- Market Volatility
- Liquidation
Sources for More Information
- Investopedia – This site provides a comprehensive and easy-to-understand overview of various financial terms including Margin Call.
- Bankrate – Another reliable source for financial information, providing insights on Margin Calls among many other topics.
- Fidelity – This is an international brokerage firm which provides deep insight into more technical finance concepts like Margin Calls.
- The Balance – This site provides articles written by finance experts. The term Margin Call can be explained within a broader context of investing and personal finance strategies here.
