Know What Triggers a Margin Call
Volatility—market swings—can sometimes bring an uncomfortable surprise to investors: a margin call.
When you buy stock on margin, your brokerage firm lends you cash, using assets in your account as collateral, to purchase securities. To trade on margin, you must have a margin account with your brokerage firm. Margin accounts are also needed when selling stocks you don’t own, known as “shorting.” In this case, your firm lends you the stock you want to sell. You also need a margin account for many options trading strategies.
How You Could Get a Margin Call
There are three ways that a margin call can be triggered:
- You execute trades that cause a margin deficit in your account.
- The value of your margin account decreases.
- Your brokerage firm raises the house maintenance margin requirements.
Let’s explore each case.
Case 1: You execute trades that cause a margin deficit in your account.
In general, under Federal Reserve Board Regulation T (commonly referred to as Reg T), firms can initially lend a customer up to 50 percent of the total purchase price of an eligible stock. This requirement applies only to new positions. In some cases, a firm might restrict you from buying or owning certain securities on margin. This can include stocks that don’t trade on a national exchange, such as the NYSE or Nasdaq, and might also include stocks the firm believes to be particularly susceptible to large daily price swings.
For example, let's say you have available margin excess of $2,000. You then buy $10,000 worth of a stock on margin, and your firm will lend you half the amount. Under Reg T, you have "one payment period," which is currently three business days from the trade date, to meet the initial margin requirement of $4,000—50 percent of $8,000 (i.e., the total purchase price less the available margin excess). However, the firm may shorten the payment period and might require you to deposit a higher initial margin amount.
If you don't meet this deadline, regardless of whether the stock you purchased on margin moves up or down, you’ll get a margin call requiring you to deposit $4,000. In exceptional circumstances, the firm may allow you additional time (known as an extension), but they aren’t required to do so. If you don’t make your deposit and the firm doesn’t grant you an extension, the firm must liquidate assets in your account. The firm can sell the shares you bought on margin or can sell other assets in your account.
Important: Though there’s no requirement to deposit cash to open a margin account, FINRA rules require your account have a value of at least $2,000 before engaging in margin trading.
(If you trade into and out of positions on the same day using margin, learn more about frequent intraday trading.)
Case 2: The value of your margin account decreases.
Another way to get a margin call is if your account equity drops below either the firm or FINRA maintenance margin requirements. When you trade on margin, your account must maintain a minimum value. Under FINRA’s new intraday margin requirements, you’re required to maintain adequate equity throughout the day, not just at the close of trading.
The term used to describe the value of a margin account may vary from firm to firm, but some common terms are “account equity,” “net worth” and “liquidation value.”
FINRA rules supplement the requirements of Reg T by placing "maintenance" margin requirements on customer margin accounts. Generally, a customer's equity in a margin account that holds margin stocks only must not fall below 25 percent of the current market value of the long securities (those the investor owns) in the account.
Firms may also set margin requirements of their own—often called "house" requirements—that can be higher than the margin requirements under Reg T or the rules of FINRA and the exchanges. For instance, a firm might set the maintenance margin at 30 or even 40 percent of the current market value of the securities in your account. Furthermore, firms may increase the house requirements at any time and aren’t required to provide you with advanced written notice.
Case 3: Your broker raises the house maintenance margin requirements.
You can get a margin call even if you didn’t trade or your account didn’t lose value. This can happen when the firm raises the house margin requirements on either a specific security or group of securities in your account. For example, a firm may increase its house margin requirements when a company is bankrupt, delisted (no longer trades on an exchange) or experiencing large daily price swings (high volatility). Firms might also apply higher house requirements to certain groups of stocks in specific industries or sectors.
Important: A firm isn’t required to notify you if your account equity drops below the minimum maintenance equity. Firms don’t have to issue a margin call before selling securities in your margin account to meet a margin call and may sell enough securities to completely pay off your margin loan, not just meet the margin call. Also, firms don’t have to let you choose which securities or assets are sold to meet a margin call.
How to Meet a Margin Call
You can address a margin call in the following ways:
- Deposit cash for the amount of the margin call.
- Deposit margin-eligible securities. When meeting a margin call with securities, the value of securities you deposit must be higher than the amount of the margin call. For example, if you have a house margin call of $6,000, and have a stock in another account with a house requirement of 40 percent, you must deposit $10,000 of that stock to meet the house margin call. The formula for doing so is as follows:
Margin call amount ÷ (100% less the margin requirement %):
$6,000 ÷ .6 = $10,000
- Sell securities in your account. The value of securities that you must sell may be significantly more than the value of the call. For example, if you have a house margin call of $6,000 and you sell a security in your account that has a house requirement of 40 percent, you must sell $15,000 to meet the house margin call. Here's the formula to arrive at this amount:
Margin call amount ÷ the margin requirement %:
6,000 ÷ .4 = $15,000
Please note that these examples only apply in situations where there is a margin loan and might not apply in accounts with short positions or options.
How to Avoid a Margin Call
These actions can help you understand what triggers a margin call and, by extension, avoid or prepare for one:
- Read your margin agreement. This may be a part of a general brokerage agreement or may be a stand-alone agreement. Either way, read the margin disclosure carefully. This is where terms and conditions of margin loans are explained, as well as how the securities you purchase serve as collateral.
- Know how your firm monitors your margin level. Some firms might conduct real-time monitoring of customers’ margin accounts and block transactions that would create intraday margin deficits. Other firms might continue to compute margin levels at the end of the day. Prepare yourself by understanding your firm’s margin account monitoring procedures—and personally monitoring your specific margin requirements throughout the day.
- Know your cushion—the maintenance margin excess in your account. This will help you understand how much your portfolio can decline in value before triggering a margin call. If you aren't sure how a maintenance call might be triggered, ask a registered investment professional to paint a scenario or two.
In short, know the rules—and stay abreast of market conditions to monitor when you might be getting close to a margin call. You might not be able to avoid a margin call, but at least it won't come as a big surprise.
