February 3, 2023
It’s the call no retail shareholder wants to receive. A margin call alerts the individual investor that the value of securities in their brokerage account, which they funded in part by borrowed money, fall below a certain point – the maintenance margin – forcing them to deposit additional cash or securities to meet the margin requirements.
In the simplest terms, a margin call is the brokerage calling in its loan to you. If you haven’t borrowed against your assets in the first place, you have nothing to fear. Buying on margin only occurs when an investor buys an asset by borrowing the balance from a broker. Buying on margin refers to the initial payment made to the broker for the asset with the investor using the marginable securities in their brokerage account as collateral, according to Investopedia.
While TiiCKER does not provide financial advice, retail investors should carefully consider the pros and cons of margin accounts before using them to purchase securities. A margin account is slightly different than a standard brokerage account in that a retail shareholder can use cash or securities in their account to take out a loan to buy more shares.
Some individual investors use these margin accounts to amplify gains by increasing their purchasing power. It is important to note that in a down market (or if the funds are used to short shares of a rising stock in a bull market), losses will be amplified as well.
That’s when the margin call comes in. If the value of securities in a margin account falls below the maintenance margin – a percentage of the equity in your account – expect a call from your brokerage. When a margin call comes in, the retail shareholder can either: deposit more money into their account to meet the maintenance margin; transfer more securities into their account to meet the maintenance margin; or sell securities (even if that means at a depressed price) to make up the shortfall.
Investors will generally have two to five days to respond to the margin call, but that might be shorter if the market is particularly volatile. And if you can’t meet the requirements to make up the margin call quickly enough for your broker, they might be able to sell your securities – without your permission – to make up for the shortage.
Margin debt is the total amount of debt outstanding in the market. Margin debt level tends to rise along with the market as investors attempt to amplify gains. The FINRA Margin Debt is at a current level of $607 billion, down from $644 billion last month and down from $910 billion one year ago. This is a decline 5.77% from last month and a drop of 33.34% from one year ago. It is important to note that margin debt is not a technical indicator and should not be used to trade markets.
Bankrate.com provides a good example of how a margin call works: Let’s say you’ve deposited $10,000 into your account and borrowed another $10,000 on margin from your broker. You decide to take your $20,000 and invest it in 200 shares of XYZ company, trading for $100 a share. Your maintenance margin is 30 percent. In this example, if the market value of the account falls below $14,285.71, you’ll be at risk of a margin call. So if the stock price of XYZ falls to $71.42 or lower, you’ll be faced with a margin call.
Let’s say Company XYZ reports disappointing earnings results and the stock falls to $60 not long after you bought it. The value of the account is now $12,000, or 200 shares at $60 per share, and you’re $1,600 short of the 30 percent margin requirement. You have a few options.
Deposit $1,600 of cash into the account to meet the margin call.
Transfer $1,600 of marginable securities into the account.
Sell $3,333.33 of XYZ stock to pay down the margin loan and boost your account equity to the 30 percent requirement.
The broker will be paid back in full for the loan and any losses are the retail shareholder’s. In the example above, you deposited $10,000 of your own money and borrowed another $10,000 on margin. The account value declined to $12,000, leaving you with just $2,000 in equity and a decline of 80 percent, despite the stock only falling 40 percent – the amplified loss described above.
For most retail shareholders, margin calls are only a problem if you are trading against a margin account. These accounts should only be used by experienced traders and with extreme caution.
Founding father George Washington said: “Worry is the interest paid by those who borrow trouble.” Take great care before buying securities on margin. Otherwise you might be borrowing trouble and getting a dreaded margin call.
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