Margin Call: What It Is, How It Works & How To Avoid It
Leverage can be a powerful thing, allowing borrowers to take on bigger projects than they otherwise could and to potentially generate bigger returns on their initial investment stake. But leverage, like buying stock on margin, also brings the risk of bigger losses if the venture does not go as well as planned—like getting a margin call.
Buying Stocks on Margin
One way investors can gain more investment exposure is by borrowing money to fund their investments either through a loan, or via buying stocks on margin, to acquire more shares than they otherwise could. When successful, investing with margin magnifies the gains, but it also carries the risk of larger losses.
Margin accounts allow investors to borrow money from the brokerage and buy stocks with that money. Margin accounts are also necessary if an investor wishes to short stocks, as shorting involves borrowing shares with the promise of one day returning those shares.
One of the key events to understand with margin investing is the margin call.
What Is a Margin Call?
A margin call is a notification from a brokerage that the investor must deposit cash, transfer in eligible securities, or sell stocks/securities to raise a specified amount of money within a period of a few days.
How Margin Calls Work
The margin call itself is a notification (typically sent by email) from the brokerage that the investor’s account equity has fallen below the minimum threshold and the investor must add a minimum dollar amount of cash or securities to the account and/or sell securities held in the account to reduce the margin debt within a specified time. If the investor meets the call, that is the end of the matter unless and until there is a further decline in the ratio of account equity to account value.
If an investor cannot meet a margin call, or chooses not to, the brokerage has the right to sell any and all securities in the account (“liquidation” or “forced sale”), and typically in any other accounts, the investor has with that brokerage, to cover the difference. These sales are solely at the brokerage’s discretion, and investors do not get to decide what securities are sold.
Tip: If a brokerage has to make forced sales, the brokerage chooses what securities to sell, and will do so regardless of valuation or tax consequences to the investor.
If the funds generated by these forced sales are not sufficient, the brokerage will require the investor to make up the shortfall, resorting to legal collections if necessary. As they also report to credit agencies, failing to cover a shortage with a brokerage may also impact an investor’s credit score. If an investor repeatedly fails to satisfy margin calls, forcing liquidation, the broker has the option to add restrictions to the account (higher maintenance margin requirements), remove the margin feature entirely, and/or terminate the account.
Brokerages can and will grant extensions on margin calls, but it is at their sole discretion and it is not an option with federal or exchange calls. It is important to remember that brokerages have wide latitude with margin calls and can demand immediate fulfillment.
Important: Brokers are not legally required to notify investors of margin calls. It is the investor’s responsibility to maintain the required minimum account equity. Investors should NOT rely on margin calls for purposes of managing a margin account.
When & Why Do Margin Calls Occur?
First, for a margin call to occur, an investor must have borrowed funds or stocks from their margin account. It is perfectly acceptable to have a margin account and never use any borrowed funds, but investors who do borrow from the brokerage will have to pay interest on those funds and may be at risk of a margin call at some point.
Important: If an investor never borrows money from the brokerage, a margin call cannot happen.
Margin calls typically occur because the value of the securities in the account has declined, reducing the investor’s equity. The key factor with margin calls is the ratio of investor equity—the value of the securities and cash in an investor’s account minus the amount of borrowed funds—to the value of the securities in the account. The ratio must always be at or above the brokerage’s minimum maintenance margin (and at/above the regulator/exchange minimums), or there will be a margin call.
For example, an investor with $10,000 of their own money has an account with $20,000 of stocks, implying that they've used $10,000 of borrowed money from the brokerage to buy those stocks. The equity of the account is $10,000 ($20,000 - $10,000), and 50% of the market value of the securities ($10,000 / $20,000).
$20,000 - $10,000 = $10,000
50% = $10,000 / $20,000
Tip: Using add-on services like check writing, debit cards, or bill payments tied to your margin account can increase the risk of a margin call by reducing equity and/or increasing margin balance.
Margin Calls for Day Traders
Day traders face different rules. If an investor is deemed a “pattern day trader”, meaning they trade four or more times within a five-day period and those activities are more than six percent of total trading activity for that period, they must have a minimum of $25,000 in equity in their account and they may trade up to four times the maintenance margin excess before triggering a margin call. Brokerages can impose stricter requirements beyond this.
Margin calls in these cases work a little differently. Until the margin call is met, the account will be restricted to trading only up to two times the maintenance margin excess, and a failure to meet the call will result in a restriction to trading only on a cash basis for 90 days or until the call is met.
Types of Margin Calls
There are three main types of margin calls. The type of margin call an investor receives depends upon which margin minimum thresholds were exceeded.
- Federal calls: Also called "initial calls", they occur when an investor cannot meet the initial minimum margin for a purchase.
- Exchange calls: These occur when the value of an investor’s account equity drops below a specified minimum percentage of the account value.
- Maintenance calls: Also called “house” or “brokerage” calls, they also occur when account equity drops below a minimum percentage of the account's value.
Who Sets Minimum Maintenance Margins?
Minimum maintenance margins are set by multiple parties, including the Fed, regulators like FINRA, individual exchanges (like the New York Stock Exchange), and the brokerages themselves. Brokerages are not allowed to offer maintenance margins below regulator or exchange minimums, but may require higher “house” maintenance margins. For instance, while the New York Stock Exchange and FINRA both require a minimum margin of 25%, individual brokerages typically set higher minimums of 30% to 40%.
House minimums are discretionary and can be changed without prior notice by the brokerage, typically during periods of elevated volatility. Minimums can also vary on a stock-by-stock basis—if a particular stock suddenly becomes more volatile (like the so-called “meme stocks” of 2020-2021), brokerages may respond by quickly raising their maintenance margin limits.
If an investor’s account falls below the brokerage’s minimum maintenance requirement (the “house minimum”), the investor will get what is called a maintenance call or a house call, and this is the most common type. Most brokerages will give investors four to five business days to meet this call. If the account falls below the exchange’s minimum, that triggers an “exchange call”, which must be met within two days.
How a Margin Call is Calculated
Margin call calculations can look complicated but are relatively straightforward, and most brokerages will offer online calculators (as will other financial information websites). Below are examples illustrating how margin calls are calculated based on type with multiple scenarios as examples.
Federal or Initial Margin Call
A federal margin call will happen when the investor cannot meet the Federal Reserve’s initial margin requirement as per Regulation T (the 50% requirement). The initial requirement is 50% of the total cost of the trade (including commissions).
Margin Call Amount = Investor's Equity - 50% of the Total Trade Cost
To illustrate the calculation, imagine an investor wants to buy shares of XYZ Corp on margin from a brokerage with a house minimum maintenance requirement of 35%. Let's assume there will be no commissions and no margin interest—these are both very real factors that investors must consider.
Here's the scenario:
- An investor opens a margin account with $9,000, intending to use it to acquire shares of XYZ Corp.
- Once the paperwork is completed and the initial deposit of $9,000 is made, the investor wants to enter an order to buy $20,000 of XYZ Corp.
- A call for additional margin would be immediately triggered: a federal (or initial) margin call.
- XYZ is trading for $100/share, so the investor purchases 200 shares.
- The account only has $9,000 of equity, so the investor will receive a federal margin call for $1,000.
$20,000 x 0.50 = $10,000
$10,000 - $9,000 = $1,000
Once the call is met, the ratio of equity to account value is 50% ($10,000 / $20,000), comfortably above the 35% minimum maintenance requirement.
Note: Brokerages can set initial margins above the Federal minimum.
Exchange or Maintenance Margin Calls
Calculating maintenance/house calls or exchange calls is a little different and is based upon the minimum maintenance margins. In these cases, the margin call amount is whatever sum is required to return the account to the minimum threshold:
Margin Call Amount = Current Equity of the Account - Amount of Equity Needed to Return the Account to the Minimum Threshold
As an example, let's assume:
- The value of XYZ declines by 20%, falling to $80 per share.
- At this point, the investor’s equity is now $6,000
200 shares x $80/share = $16,000
$16,000 - $10,000 of borrowed money = $6,000
The ratio of equity to account value is $6,000 / $16,000, or 37.5%. The investor is still above the house minimum maintenance threshold of 35%, so the investor will NOT receive a margin call and does not have to take any actions.
- Now consider a situation where unfortunately the value of XYZ continues to decline, falling another $10 to $70/share.
- Now the equity value is just $4,000
200 shares x $70/share = $14,000
$14,000 - $10,000 = $4,000
The ratio of equity to account value is now 28.6% ($4,000 equity / $14,000 account value). That 28.6% ratio is below the 35% house minimum and the investor will receive a margin call.
The margin call amount will be the difference between the current equity and the amount needed to satisfy the maintenance minimum ratio—in this case that is $900.
$14,000 x 0.35 = $4,900
$4,900 - equity of $4,000 = $900
The investor must either deposit $900 in cash or transfer $900 worth of eligible securities into the account.
The investor can also choose to sell part of the position to reduce the margin loan. In that case, the calculation is as follows—divide the amount of the margin call ($900) by the minimum threshold (0.35), and divide that amount by the price of the shares to be sold ($70).
($900 / 0.35) / $70 = 36.7 shares
Rounding up, selling 37 shares at $70 would generate proceeds of $2,590 and would lead to the following equation for the account. The account value has now declined to $11,410
163 shares x $70/share = $11,410
But the margin loan has declined to $7,410
$10,000 - $2,590 = $7,410
The equity value remains $4,000.
$11,410 - $7,410 = $4,000
The ratio equity to account value is now just above the minimum.
$4,000 / $11,410 = 35.1%
Important: Investors meeting a margin call can sell whatever positions they have in that account. While this example used a single stock in a single account, if the investor owned other stocks and received a margin call, they could sell any stock they wished to reduce the margin loan and meet that call. This is one of the reasons not to ignore a margin call and let the brokerage decide to liquidate positions—if the investor directs the selling, they can choose which positions to sell.
Avoiding a Margin Call
Here are six tips that could help you avoid a margin call.
1. Do Not Used Borrowed Funds
The simplest way to avoid a margin call is to not use borrowed funds to buy stocks and to limit purchases to whatever cash is in the account. While many brokers will want to set up new accounts as margin accounts from the start, investors are under no obligation to use the account that way.
2. Use Less Than the Maximum Margin
Another option is to use less than the maximum margin. While a broker may allow an investor to use borrowed funds for up to 50% of the transaction amount, there is no obligation to do so. Using 10% borrowed funds, for instance, would still give an investor some of the benefits of margin (extra buying power) but with a larger equity buffer.
3. Avoid Volatile Securities
Avoiding volatile securities can also potentially reduce the risk of margin calls; securities that swing wildly within a day can more easily trigger margin calls, and likewise may be subject to sudden changes in maintenance margin requirements. It is also possible to reduce risk by holding securities with inverse correlations, but the risk here is that uncorrelated or inversely-correlated assets can see those correlations change quickly in periods of major market turbulence (as happened in the Global Financial Crisis).
4. Monitor Your Accounts Closely
Investors should also make it a practice to watch their accounts closely, adding cash/securities or trimming positions back (selling stocks to raise cash) to keep sufficient equity in the account.
Tip: Margin calls are meant to protect the brokerage and the brokerage’s interests. They are not meant to protect investors. Waiting until a margin call to act is a little like using a kitchen’s smoke alarm instead of a timer to decide when to take the meal out of the oven.
5. Use Leveraged ETFs
Another option to consider is the use of leveraged ETFs. These investments make use of leverage within the fund to magnify the returns, but individual investors do not take on the personal risk of directly employing leverage (like margin call risk).
6. Use Stop-Loss Orders or Price Alerts
Tools explicitly meant to avoid margin calls aren’t that common, but there are tools that can be used for that purpose. Investors can calculate what sort of security prices would trigger a margin call and set stop-loss orders at (or ideally, above) those levels.
Also, many online brokerages allow investors to sign up for price alerts so they can get almost-real-time notifications if a stock is moving lower.
FAQ
Most brokerages will notify investors of margin calls before trading opens on the morning of the day after the equity in the account fell below the minimum threshold. Brokerages have the option, though, to issue them in real time (or not at all), and may do so in periods of high volatility, including demands for immediate satisfaction instead of their typical stated grace period.
Margin works differently with options, as investors are not allowed to use margin to buy options, but must have cash on hand to write options, with that cash acting as collateral to guarantee fulfillment of the options sold. Should the position move against the investor, they can receive a margin call to add cash/securities to restore the equity ratio.
No. Liquidation refers to the brokerage exercising its right to sell securities in the margin account to meet the margin call. Failing to meet a margin call can lead to liquidation, but they are not the same, as liquidation follows an unfulfilled margin call.
This article was written by
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