A margin call is a situation whereby an investor is called upon by a broker to fund their account in order to meet the minimum amount required. The minimum threshold is set by regulatory authorities such as FINRA.
When a trader’s position falls below the set minimum, a broker can either contact the customer to request them to top up their account by adding funds or by liquidating some of the customer’s stock. However, it is worth noting that brokers are not obligated to contact customers. For that reason, some brokers usually choose the easier route of selling part of customers’ stake. As good practice, however, many brokers inform their customers when their position falls below the required minimum.
Types of margin calls
- Federal Regulation T Call: As per regulations, an investor must have at least 50 percent of their funds covering the initial margin. You will receive a call if, at the time of opening an account with your broker, you did not commit at least half of your funds to purchase the asset.
- Maintenance Margin Call: This is the most common margin call. Investors encounter it when, in the course of the trading cycle, the asset goes against a trading position, leading to losses. An investor will receive this call if these losses lead to an investor’s account falling below the broker’s set minimum maintenance margin.
The appreciation and depreciation of the value of an investor’s stock usually lead to the expansion and reduction of their stock in instances when they used stock as collateral. On the other hand, however, the balance on the maintenance margin will either remain the same or grow. This is what leads to otherwise stable financial positions attracting margin calls. It is also worth remembering that the margin loan will almost certainly be subjected to interest. This also increases the chances of a margin call for a poorly performing asset/stock.
What to do about margin calls
First, you should know how much you need to cover your margin. Secondly, having known how much you need to pay, you can then deposit enough money in the margin account. Alternatively, you can deposit stock of an equivalent value to the account if the option is allowed by your broker.
If you are unable to cover the margin, your broker will have to sell your assets in their portfolio. This is usually a great disadvantage to traders because brokers have the right to dispose of your assets without consulting you further. If you had a mix of stock from Apple and Netflix, for example, they may choose to sell your Apple stock, which may not be to your liking.
If, for example, a person wants to invest $2,000 in stock through a broker whose maintenance margin is 30%. At a 50% initial margin, the investor will receive a margin call at $714.2 calculated as follows:
Therefore, the margin call will come if the asset’s market price goes below $714.28.
How to stay away from margin calls
1. Deposit enough hedge cash in your account
Also known as cash offers, this strategy involves using the margin call account optimally by ensuring that at any given time, it has enough money to cover your marginal balance obligations. You can do this by studying the market and adding funds to the account whenever your stock’s position is nearing the red.
2. Spread your risks
The securities market is unpredictable, and many factors may make even the best investors lose money. As a precaution, you should have an investment portfolio consisting of different assets, ranging from stocks of different companies to bonds and futures. By having such a rich mix, you significantly minimize the chances of incurring a net loss. This will also safeguard you against margin calls.
3. Keep track of your interest payment
As an investor, interest charges on your account will be applicable for as long as you are actively involved with a broker. Therefore, to keep your account safe from marginal calls, you should ensure that the money you have in your account can cater to the interest charges. This will also protect you from the burden that comes with the piling up of your loan obligations, thereby freeing you to concentrate on investment strategies.
4. Work out your minimum balance
This is an effective way of ensuring that at any given time, you have enough money in your account to cover the broker’s needs and cushion you against sudden losses. The minimum balance should be topped up regularly to maintain a safe buffer from the broker’s maintenance margin balance. The greatest benefit of this strategy is the assurance that your assets are not in danger of being sold by the broker even when the market goes against you during certain periods.
Margin calls are an investor’s nightmare. However, with the right account maintenance strategy and tracking of the market, a smart trader can keep off margin calls. It is therefore important that you understand the market well as well as your broker’s terms of trade.