How to Calculate When a Margin Call Will Happen

Investors use margin accounts to amplify purchasing power by borrowing funds from a brokerage firm. While this strategy offers potential for magnified returns, it also introduces increased risk, particularly the possibility of a “margin call.” Understanding how these calls are triggered and what they entail is crucial for anyone considering or engaging in margin trading, as it can significantly impact an investment portfolio. This article explains the core components of margin accounts and details the mechanics of determining when a margin call might occur.

Fundamentals of Margin Accounts

Margin trading allows investors to buy more securities than they could with their available cash by using money borrowed from their broker. The purchased securities often serve as collateral for this loan, enabling an investor to control a larger market position. This amplified buying power can lead to greater profits if investments perform well, but it equally magnifies potential losses.

Margin accounts involve two concepts: initial margin and maintenance margin. Initial margin is the percentage of a security’s total purchase price an investor must pay with their own funds when opening a new position. For stocks, Regulation T of the Federal Reserve Board often sets this at a minimum of 50%, though brokerage firms may require higher percentages.

Maintenance margin is the minimum equity an investor must maintain in their margin account after a purchase to keep the position open. While the Financial Industry Regulatory Authority (FINRA) sets a minimum maintenance margin of 25% of the total value of securities, many brokerage firms establish their own, often higher, requirements, typically ranging from 30% to 40%.

Account equity represents the investor’s ownership stake in the margin account. It is calculated as the current market value of the securities held minus the amount borrowed from the broker. As the market value of securities fluctuates, so does the account equity, directly influencing whether the maintenance margin requirement is met.

Determining a Margin Call Trigger

A margin call is issued when the equity in an investor’s margin account falls below the required maintenance margin percentage. This occurs when the investor’s equity is less than the maintenance margin percentage multiplied by the total market value of the securities.

The formula to calculate the price at which a margin call will be triggered, assuming a single security, is:

Margin Call Price = (Amount Borrowed) / (1 – Maintenance Margin Percentage)

For example, suppose an investor purchases $20,000 worth of stock using a margin account. With an initial margin requirement of 50%, the investor pays $10,000, borrowing the remaining $10,000 from the broker. If the brokerage firm has a maintenance margin requirement of 30%, the margin call price would be $10,000 (amount borrowed) divided by (1 – 0.30), which equals $10,000 / 0.70, or approximately $14,285.71. If the total market value of the securities drops to this amount, a margin call will be triggered.

At this triggered market value of $14,285.71, the investor’s equity would be $14,285.71 (current market value) minus $10,000 (borrowed amount), resulting in an equity of $4,285.71. This equity precisely equals 30% of the current market value ($14,285.71 0.30 = $4,285.71), hitting the maintenance margin threshold. If the market value falls further, the equity percentage drops below the required maintenance margin, prompting the margin call from the broker.

Actions After a Margin Call

Once a margin call is issued, the investor must take action to bring their account equity back up to the required level. Brokers typically provide two to five business days to meet the call. The most direct ways to satisfy a margin call include depositing additional cash or transferring fully paid, marginable securities from another account.

Alternatively, an investor can sell some securities held in the margin account to reduce the borrowed amount and increase the equity percentage. However, this option might force liquidation at unfavorable market prices, potentially locking in losses. If an investor fails to meet the margin call within the specified timeframe, the brokerage firm can forcibly sell securities in the account without prior notice to cover the shortfall.

Forced liquidation means the broker can choose which assets to sell, regardless of investor’s preferences or current market conditions, which can lead to significant financial losses. Failure to meet a margin call can also result in additional fees and negatively impact the investor’s standing with the brokerage firm, potentially affecting future trading opportunities. Investors should monitor their margin accounts closely and understand the implications of market movements on their equity.