When Do Margin Calls Happen and What Should You Do?

Trading on margin allows investors to amplify potential returns by borrowing money from a brokerage firm to purchase securities, using the acquired investments as collateral. While margin trading enhances buying power, it also introduces risks, primarily the possibility of a margin call. A margin call is a formal notification from a brokerage firm, demanding an investor deposit additional funds or securities into their margin account. This demand arises when the account’s equity falls below a predetermined minimum level, known as the maintenance margin. Its purpose is to ensure the investor maintains sufficient collateral to cover borrowed funds.

Understanding Margin Accounts

A margin account uses leveraged investing, combining an investor’s capital with borrowed funds to buy securities. Investors must meet an initial margin requirement, the percentage of the purchase price paid with their own money. Regulation T mandates an initial margin of 50% for most securities. For example, buying $10,000 worth of stock requires a $5,000 contribution from the investor.

Investors must also adhere to a maintenance margin requirement, the minimum equity percentage maintained in the account relative to the total value of securities. FINRA sets a minimum maintenance margin of 25% for most equity securities, but brokerage firms often set higher “house” requirements, typically 30% to 40%, for added risk protection. This ensures the investor’s equity, calculated as market value minus loan amount, does not fall too low.

Conditions Triggering a Margin Call

A margin call is triggered when an investor’s account equity drops below the maintenance margin requirement. The most common cause is a significant fall in the market value of securities held on margin. As investment prices decrease, the investor’s equity (market value minus borrowed amount) diminishes, falling below the required percentage.

Brokerage firms can also unilaterally increase their maintenance margin requirements at any time, even without prior notice. Such an increase can trigger a margin call, regardless of market value changes. Firms typically take this action to protect themselves from heightened market risk or increased volatility.

Holding a highly concentrated position in a single, volatile stock also elevates margin call risk. If that stock experiences a sharp price decline, the account’s equity can quickly fall below the maintenance threshold. For instance, some firms may impose a higher maintenance margin, sometimes 50%, for concentrated accounts where a single position constitutes a large percentage (e.g., 60% or more) of the total marginable market value. Additionally, withdrawing cash from a margin account can reduce equity. If a cash withdrawal causes equity to fall below the maintenance margin level, it will trigger a margin call.

Calculating a Margin Call

Upon receiving a margin call, an investor must deposit funds or securities to bring their account’s equity back to the maintenance margin level. The margin call amount is determined by assessing the current market value of securities and the required maintenance percentage, then comparing it to existing equity. The calculation aims to restore the account to the minimum equity threshold.

For example, consider an account with a current market value of $10,000 and an outstanding loan of $5,000, resulting in $5,000 equity. If the firm’s maintenance margin is 30%, the required equity for a $10,000 portfolio is $3,000 ($10,000 0.30). If the market value drops to $7,000, equity falls to $2,000 ($7,000 market value – $5,000 loan). In this scenario, the account’s $2,000 equity is below the required $2,100 ($7,000 0.30). The margin call amount would be $100, the difference needed to reach the maintenance margin. Brokerage firms specify the exact amount of funds or securities required.

Responding to a Margin Call

Upon receiving a margin call, an investor typically has two to five business days to address the deficiency, though some brokers may require sooner action. Prompt action avoids forced liquidation. Investors can respond in several ways.

The most straightforward method is to deposit additional cash into the margin account, directly increasing equity above the maintenance margin. Another option is to deposit fully paid-for securities not currently held on margin, adding to the account’s equity.

Investors can also sell existing securities within their margin account. Selling assets reduces the outstanding loan, increasing the equity percentage relative to the remaining market value. If an investor fails to meet a margin call within the specified timeframe, the brokerage firm can sell securities in the account without prior notification to cover the deficit. This forced liquidation can occur regardless of current market prices, potentially locking in losses.

Strategies to Prevent Margin Calls

Proactive margin account management can reduce the likelihood of a margin call. Maintaining ample cash reserves, either within the account or readily accessible, provides a buffer against market downturns or increased margin requirements. This cash can be quickly deployed to satisfy potential calls.

Regularly monitoring the account’s portfolio value and equity percentage is important, especially during market volatility. Understanding the specific maintenance margin requirements set by the brokerage firm, which may be higher than regulatory minimums, allows investors to anticipate issues.

Diversifying the investment portfolio across various asset classes, industries, and geographies can mitigate the impact of a significant price drop in a single security. A well-diversified portfolio is less susceptible to a concentrated decline that could trigger a margin call. Using margin prudently, avoiding excessive leverage, and borrowing only a portion of the maximum allowed amount can provide a cushion against adverse market movements.