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Margin trading, the practice of using borrowed funds to place bigger trades, comes with strict requirements, including the amount of cash required to place a margin trade (initial margin), and how much cash or equity as collateral must remain in the account (maintenance margin).
The two requirements are similar in that they both refer to the amount of collateral the broker requires an investor to have in their account in order to open or maintain a position with a margin loan.
The main difference between the two is that the initial margin is the amount of money required to open a position, while the maintenance margin is the amount needed to keep one or more positions open.
Key Points
• Initial margin is the amount of money required to open a position, while maintenance margin is the amount needed to keep one or more positions open.
• The Federal Reserve Board’s Regulation T mandates a minimum initial margin deposit of 50% for stock purchases.
• FINRA sets the minimum maintenance margin requirement at 25% of the total market value of securities bought on margin.
• Both initial margin and maintenance margin function as collateral required by the broker to cover potential losses from a margin loan.
• If an investor’s equity drops below the maintenance margin, the broker may issue a margin call or sell assets to restore the required balance.
What Is Initial Margin?
Because margin trading is considered a higher-risk strategy, whether you’re investing online or through a traditional brokerage, only investors that meet certain criteria and follow specific requirements before they can trade on margin.
To open a margin account, investors must deposit 50% of the securities they want to buy, or $2,000, whichever is larger. In addition, investors must pass a basic screening and meet certain criteria (e.g., investment knowledge, credit history, etc.). Once the margin account is established, investors must provide initial margin for each subsequent trade.
Initial Margin Requirements
Initial margin is the minimum amount of cash or collateral an investor must deposit in a margin account in order to buy securities on margin.
The Federal Reserve Board’s Regulation T requires a minimum initial margin deposit of 50% for stock purchases. Meaning: Investors must have cash or collateral to cover at least half of the market value of stocks they buy on margin.
However, Regulation T only sets the minimum for margin accounts. Stock exchanges and brokerage firms can set their initial margin requirement higher than 50% based on a stock’s volatility, the state of the markets, or other considerations.
How Initial Margin Works
If you meet the initial margin requirement of having 50% in cash or equity as collateral, your broker may provide you with a margin loan to cover the rest of the trade’s purchase price. For example, if an investor wants to purchase $6,000 of stock, then the investor will have to cover an initial margin of $3,000 with cash or other equity and borrow $3,000 from the broker to make the trade.
Investors use margin trading as a way to increase their buying power. In the example above, if the investor bought the same amount of stock in a cash account, then they would need $6,000 in cash to make the trade. By using margin, the investor doubles their buying power by using only $3,000 to buy $6,000 worth of stock.
However, using margin involves risk, and may lead to more significant losses than buying stock directly in a cash account. If a trade declines below the threshold, investors will need to bring it back up to effectively pay back the margin loan.
Recommended: Cash Account vs Margin Account: Key Differences
What Is Maintenance Margin?
Maintenance margin is the minimum amount of equity an investor must keep in their margin account after making a trade. The margin equity in the account is the value of securities minus the amount of the margin loan borrowed to make the trade. If the account’s equity falls below the maintenance margin, the broker may issue a margin call or close out the investor’s trade.
Maintenance Margin Requirements
Maintenance margin is usually expressed as a percentage of the position’s value. The Financial Industry Regulatory Authority (FINRA), which regulates maintenance requirements, says maintenance margin must be at least 25% of the total market value of the securities bought on margin. However, like initial margin, brokerage firms may have higher maintenance requirements, depending on various factors like market volatility and liquidity.
How Maintenance Margin Works
Suppose an investor purchased $6,000 worth of stock by paying $3,000 in cash and borrowing $3,000 from their broker, and the broker has a 25% maintenance margin requirement. If the market value of the stock drops from $6,000 to $5,000, the investor’s equity will now be $2,000 ($5,000 – $3,000 margin loan) and the maintenance margin will be $1,250 ($5,000 x 25%). In this case, the investor still has enough equity to cover the maintenance margin.
However, if the stock’s value drops to $3,500, the investor will no longer have enough equity to cover the maintenance margin requirement. The investor’s account has $500 in equity ($3,500 – $3,000), while the maintenance margin is $875 ($3,500 x 25%).
If the investor doesn’t restore the correct balance in the account within a few days, the broker may issue a margin call, requiring the investor to deposit additional funds into the account — or sell assets to increase the equity in the account.
The broker may also sell some of the investor’s holdings without notifying them to bring the account back up to the maintenance margin level.
The purpose of the maintenance margin is to protect the broker in case the value of the securities in the account falls.
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Initial Margin vs Maintenance Margin
Here’s a quick look at how initial margin and maintenance margin stack up:
| Initial Margin vs Maintenance Margin | |
|---|---|
| Initial Margin | Maintenance Margin |
| 50% minimum initial margin requirement regulated by the Federal Reserve Board’s Regulation T | 25% minimum maintenance margin requirement regulated by FINRA |
| Initial margin is deposited at the start of a trade | Maintenance margin is required for all open positions |
Similarities
Initial margin and maintenance margin are similar in that they are both used as deposits to cover potential losses in a margin account. These margin requirements are each calculated as a percentage of the value of the account’s assets.
Additionally, both initial margin and maintenance margin can be increased or decreased by an exchange or brokerage firm, depending on a stock’s volatility, the financial situation of a client, and other factors.
In either case, a brokerage can set their own requirements for initial or maintenance margin.
Differences
The initial margin is the amount of cash or collateral an investor must deposit with a broker when buying or selling an asset on margin. In contrast, the maintenance margin is the minimum amount of equity an investor must maintain in their account to keep the account open and avoid a margin call. Another difference between the two is that initial margin is typically higher than maintenance margin.
Calculating Initial and Maintenance Margin
There are formulas for calculating both initial margin and maintenance margin.
Initial Margin Calculation
The formula for calculating initial margin is:
Initial margin = initial margin percentage x total purchase price of security
So, if a brokerage firm has an initial margin percentage of 65% and an investor wants to buy $10,000 worth of stock ABC, then the initial margin for that trade would equal $6,500:
$6,500 initial margin = 65% initial margin percentage x $10,000 total purchase price
In this scenario, the investor would need to have $6,500 in an account and borrow $3,500 with a margin loan.
Maintenance Margin Calculation
The formula to calculate maintenance margin is:
Maintenance margin = Total value of securities owned on margin x maintenance margin percentage
If a brokerage firm has a maintenance margin percentage of 30% and an investor holds $1,000 of stock XYZ (100 shares at $10 per share) in their margin account, then the maintenance margin would equal $300:
$300 = $1,000 x 30% maintenance margin percentage
In this scenario, the investor would need to have $300 in equity in their margin account to avoid being subject to a margin call.
The Takeaway
Understanding the similarities and differences between initial and maintenance margin is essential before investors can start trading on margin. Utilizing margin can help investors increase their buying power, but it comes with more risk, and the higher potential for losses.
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FAQ
Why is initial margin higher than maintenance margin?
The initial margin is higher because the Federal Reserve Board’s Regulation T sets a 50% minimum initial margin requirement, while FINRA sets a lower 25% minimum maintenance margin requirement.
How do you calculate maintenance margin?
Maintenance margin is the minimum equity an investor must have in the margin account after making a trade. Maintenance margin is expressed as a percentage of an investor’s total trade. Investors can calculate maintenance margin by multiplying the maintenance margin percentage by the total value of the margin account.
What is a margin call?
If the balance of cash or equity in an investor’s account falls below the required minimum maintenance margin, and if the investor doesn’t bring up the balance in a timely fashion, the brokerage can issue a margin call — demanding that the investor restore the maintenance margin, or selling off securities in the account to do so.
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