What is a Margin Call & How to Avoid Margin Calls?

A Margin Call is an important concept in trading and investing particularly in leveraged accounts. It occurs when an investor’s account value falls below the broker’s required maintenance margin. In such situations, the broker demands the investor to deposit additional funds or securities to restore the account to the required level. Failing to meet a margin call can lead to the broker liquidating assets in the account to cover the shortfall.

What is a Margin Call?

Margin Call Meaning is a broker’s demand for an investor to add funds or securities to their account when its value drops below the required margin level. This usually happens due to a fall in the value of leveraged positions. If the investor doesn’t meet the margin call the broker may sell assets to cover the shortfall.

Features of Margin Call

A margin call is triggered when an investor’s account value falls below the required margin level. It protects brokers from losses by requiring additional funds or asset sales.

• Triggered by Equity Drop: Occurs when account value dips below maintenance margin.
• Demand for Additional Funds: Investors must deposit cash or securities.
• Broker’s Right to Sell: If unmet, brokers can liquidate assets.
• Linked to Leverage: Common in margin trading with borrowed funds.
• Risk Management Tool: Helps control credit risk for brokers.

How Does Margin Call Work?

Margin trading allows investors to borrow money from a broker to buy more securities than they can afford with their own funds. To begin margin trading, investors must meet the minimum margin requirement, which is the initial deposit set by the broker or regulator. This deposit acts as collateral for the borrowed amount and is usually expressed as a percentage of the total trade value.

Once trading begins the investor must maintain a certain maintenance margin, which is the minimum account balance required to keep positions open. A margin call occurs if the account’s equity falls below the maintenance margin due to market losses. In such cases, the broker demands additional funds or securities to restore the account balance. If the investor fails to act the broker may liquidate some or all of the holdings to recover the borrowed funds. This ensures that the broker’s risk is managed while complying with trading regulations

Margin Call Example

1. Initial Setup
   An investor opens a margin account with a broker. The broker requires an initial margin of 50% for any securities purchased. If you buy shares worth ₹1,00,000 you need to deposit ₹50,000 of your own funds and can borrow the remaining ₹50,000 from the broker.
2. Value Drop
   After some time, the value of the shares drops to ₹60,000. The investor’s equity is now the value of the shares minus the loan from the broker.
   • The investor owes ₹50,000 to the broker.
   • The shares are now worth ₹60,000.
   • The investor’s equity = ₹60,000 (current value of shares) – ₹50,000 (loan) = ₹10,000.
3. Maintenance Margin Requirement
   The broker’s maintenance margin requirement is 25%. This means the investor must maintain at least ₹15,000 in equity (25% of ₹60,000).
4. Margin Call
   Since the investor’s equity is only ₹10,000 which is below the required ₹15,000 the broker issues a margin call. This means the investor must deposit additional funds to restore the equity to the required ₹15,000.
5. Failure to Meet Margin Call
   If the investor fails to add the required funds the broker may sell some or all of the investor’s holdings to recover the borrowed ₹50,000 and cover the shortfall.

Formula for Margin Call Price 

To understand how to calculate the price at which a margin call may occur you can use the following formula.

Margin Call Price = Initial Purchase Price × [(1 – Initial Margin) ÷ (1 – Maintenance Margin)]

For example if you have borrowed ₹1,00,000 with an initial margin of 50% and the maintenance margin requirement is 30% the margin call price would be calculated as follows.

Margin Call Price = ₹100,000 × [(1 – 0.50) ÷ (1 – 0.30)]

Margin Call Price = ₹71,430

Which means you will get a margin call if your securities value falls to below ₹71,430. If you manage to compute this price you will be able to monitor your investments and take action based on the margin call.

Causes of a Margin Call

A margin call occurs when the value of an investor’s account falls below the broker’s required minimum margin. This typically happens due to:

• Market Decline: A drop in the price of securities held on margin reduces the account’s equity.
• High Leverage: Using borrowed funds amplifies losses making the account more vulnerable to margin calls.
• Volatility: Sudden market fluctuations can quickly decrease asset values.
• Increased Margin Requirements: Brokers or regulators may raise margin requirements triggering calls even without price drops.
• Poor Risk Management: Overtrading or lack of diversification can increase exposure to margin calls.

Understanding these causes helps investors manage risks and avoid forced liquidation.

What Happens if You Get a Margin Call?

A margin call occurs when your account equity falls below the broker’s required maintenance level. You must act fast to avoid forced liquidation.

1. Notification: Your broker will notify you that your account has fallen below the minimum required margin. This could happen due to market losses or because your account balance drops below the margin maintenance level.
2. Additional Funds Required: You’ll be asked to either deposit more cash into the account or add more securities to meet the margin requirement.
3. Liquidation: If you fail to meet the margin call, your stock broker has the right to sell some or all of your securities to bring the account back into compliance. This can happen without your consent.
4. Potential Losses: If securities are liquidated to cover the margin call, you may incur losses, especially if the market value of your holdings has declined significantly.

How to Respond to a Margin Call

A margin call requires immediate attention to restore your account’s equity. Ignoring it can lead to forced liquidation by your broker.

Option 1: Deposit Additional Funds

One response to a margin call is to add money to your margin account. This will boost your equity and help you maintain the margin requirement. Adding cash prevents you from needing to sell securities which can be helpful during a market pullback.

So, say you get a margin call of ₹10,000. Deposit that amount and your equity is restored keeping your investments safe. This option is usually preferred by investors who are confident in their holdings in the long term.

Option 2: Sell Some Securities

If adding funds isn’t practical, another option is to sell some of your securities to free up cash. This can help bring your account back up to the necessary equity level. However if you liquidate securities during a downturn you may be locking in losses and it is essential to think about the long-term effects of that decision.

If your portfolio value is ₹50,000 selling parts of your holdings can help you meet the margin call if you need to raise ₹10,000. However you should consider whether selling at that moment aligns with your overall investment strategy.

How to Avoid Margin Calls

Preventing margin calls helps maintain financial stability and control over your investments.

• Maintain a Cushion: Always keep extra funds in your margin account above the minimum requirement.
• Avoid Over-Leveraging: Don’t borrow the maximum allowed; keep leverage within manageable limits.
• Monitor Your Portfolio: Regularly check market movements and your margin levels.
• Diversify Investments: Spread your investments to reduce the impact of losses from one asset.
• Use Stop-Loss Orders: Automatically limit losses by triggering sales when prices drop to set levels.
• Stay Updated on Broker Policies: Know your broker’s margin requirements and updates to avoid surprises.

Consequences of Ignoring a Margin Call

Failing to act on a margin call can lead to serious financial consequences.

• Forced Liquidation: The broker may sell your securities without prior notice to cover the shortfall.
• Loss of Investment Control: You lose control over which assets are sold and at what price.
• Additional Fees: Brokers may charge fees for executing margin calls or forced liquidations.
• Negative Account Balance: If the market drops sharply, you may still owe money after the assets are sold.
• Credit Score Impact: If the unpaid balance is reported or pursued legally, it may impact your credit.
• Broker Relationship Damage: Repeated margin issues can affect your credibility with the brokerage.

Conclusion

Effectively managing margin calls is crucial for safeguarding your investments. By monitoring your margin balance, using leverage responsibly, and acting promptly when a margin call occurs, you can mitigate risks, avoid forced liquidation, and maintain a healthy trading relationship with your broker.