RiskPicksWhat is a Margin Call?
A margin call happens when the value of your margin account drops below your broker's required maintenance margin level. Your broker demands that you either deposit more cash, sell positions to free up equity, or both. If you do not act, the broker can (and will) liquidate your positions without your permission.
How it happens
- You have $20,000 in cash and borrow $20,000 on margin to buy $40,000 worth of stock
- The stock drops 30%. Your position is now worth $28,000
- You owe $20,000 on margin. Your equity is $28,000 - $20,000 = $8,000
- Your broker requires 25% maintenance margin: 25% of $28,000 = $7,000
- Your equity ($8,000) is above the requirement ($7,000), so no margin call yet
- The stock drops another 10%. Position worth $24,000. Equity = $4,000. Requirement = $6,000
- You are below the requirement. Margin call issued
What happens next
- Deposit funds: add cash to bring your equity above the requirement
- Sell positions: liquidate enough holdings to reduce the margin loan
- Forced liquidation: if you do not respond (usually within hours to one business day), your broker sells your positions at market price. They choose what to sell, not you, and they will sell whatever fills fastest
How to avoid margin calls
- Do not use maximum margin: just because you have 4x buying power does not mean you should use it
- Use stop losses: cut losing positions before they eat into your margin cushion
- Monitor your equity: know your margin requirement and how close you are to it at all times
- Be cautious with overnight holds on margin: gap downs can blow through your cushion before the market even opens
A margin call at 9:30 AM on a gap down is one of the worst experiences in trading. The broker sells your positions at the worst possible time into the worst possible prices. Use margin carefully.