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Qualified investors can place trades in a margin account using borrowed funds, but they’re required to keep a minimum balance in the account as collateral. Investors could face a margin call — a demand from their broker to cover a shortfall with cash or equity — if liquid funds drop below that level.
If the investor doesn’t restore the minimum balance, or maintenance margin, within a certain period, the brokerage may sell securities in the account.
Margin calls are designed to protect both the brokerage and the client from bigger losses. Here’s a closer look at how margin calls work, as well as how to avoid or cover a margin call.
Key Points
• When an investor trades on margin, they are using borrowed funds to place bigger trades.
• If the equity in a margin account falls below the maintenance margin, a margin call is issued by the brokerage firm.
• When a margin call is triggered, the investor must deposit cash or sell investments to meet minimum collateral requirements in their margin account.
• If the investor doesn’t cover the shortfall within a specific period of time, usually up to five days, the brokerage can sell securities from the investor’s account to restore the minimum balance.
• A margin call exists to protect the investor and the brokerage from greater losses.
Margin Call Meaning and Definition
Qualified investors are allowed to borrow funds from a brokerage to purchase more securities than they can with cash on hand: a.k.a., buying on margin.
Margin use is high risk and complex, and investors must follow strict industry rules. This is why only certain investors qualify for margin use when investing online or through another channel.
Basic Margin Rules
The use of margin requires understanding the initial margin vs. maintenance margin: the difference between the initial collateral deposit required and the minimum balance that must be maintained (more on that below).
Investors who use margin usually do so for short-term vs. long-term investments, like trading securities with the aim of making quick gains, not investing for long periods, as for retirement.
Owing to the greater volatility of many short-term trades, a margin account may fall below the required maintenance level, triggering a margin call. The definition of a margin call is when a brokerage firm demands that an investor add cash or equity into their account because it has dipped below the required minimum amount.
Margin in Retirement Accounts
The use of borrowed funds to invest within retirement accounts such as IRAs or 401(k)s is not allowed. Retirement accounts are for long-term investments in an individual’s financial security.
That said, there is something called limited margin in a Roth IRA or traditional IRA, which allows investors to place trades using unsettled funds, without worrying about good faith violations. But these features are limited, and it’s not possible to borrow against the value of the securities in the account, execute short sales, or use any type of leverage.
How Do Margin Calls Work?
A margin call usually follows a loss in the value of investments bought with borrowed money from a brokerage (known as margin debt). A house call, sometimes called a maintenance call, is a type of margin call that can occur during market hours or as a result of after-hours trading.
A brokerage firm will issue the house call when the market value of assets in a trader’s margin account falls below the required maintenance margin — usually 25% of the value of the securities in the account, per Financial Industry Regulatory Authority (FINRA) and New York Stock Exchange (NYSE) rules. Some brokerages set the maintenance margin at 30% or 40%.
This is the minimum amount of equity a trader must hold in their margin account, but a broker may require a higher amount.
If the investor fails to honor the margin call, when trading stocks or other securities, meaning they do not add cash or equity into their account, the brokerage can sell the investor’s assets without notice to cover the shortfall in the account.
A margin account entails a high level of responsibility and potential risk, which is why margin trading is primarily for experienced investors, whether investing online or through a traditional brokerage.
Regulation T
The Federal Reserve Board’s Regulation T states that the initial margin level should be at least 50% of the purchase price of the securities the investor hopes to trade. For example, a $10,000 trade would require an investor to use $5,000 of their own cash for the transaction.
FINRA
FINRA requires that investors keep a maintenance margin level of at least 25% of the market value of all securities in the account. For example, in a $10,000 trade, the investor must maintain $2,500 cash in their margin account. If the equity value in the account falls below 25% of the total, the investor could be subject to a margin call.
Again, some brokers may impose tighter restrictions on margin accounts. Experienced traders will be sure to note the terms of all margin trades.
Recommended: Regulation T (Reg T): All You Need to Know
Example of a Margin Call
Here is how a margin trade works. Suppose an investor wants to buy 200 shares of a stock in the U.S. stock market, at $50 each for a total of $10,000. The investor puts up $5,000 in initial margin, while the brokerage firm lends the remaining $5,000.
FINRA rules and the broker require that the investor hold at least 25% of the total securities value in his or her account at all times — this is the maintenance margin requirement (which can vary by broker). So the investor would need to maintain $2,500 in his or her brokerage account. The investor currently achieves this since there’s $5,000 in equity from the initial investment.
If the stock’s value falls to $30 per share, the total value of the investment drops to $6,000. The broker is entitled to $5,000 (to repay the margin loan), not including interest or fees, leaving approximately $1,000. That would be below the $1,500 maintenance margin required, or 25% of the total $6,000 value in the account.
Recommended: Stock Market Basics
What Triggers a Margin Call?
Once the equity balance in the margin account falls below the required amount, that can trigger a margin call — especially if the investor does not respond to requests to address the shortfall. Normally, a broker will allow two to five days for the investor to cover the margin call.
In the above example, the drop in stock price would trigger a margin call of $500, which is the difference between the $1,000 in equity in the account and the $1,500 required to maintain the margin account. In addition, the investor would also owe interest and possibly fees on the margin loan of $5,000.
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Margin Call Formula
Here’s how to calculate a margin call:
Margin call amount = (Value of investments multiplied by the percentage margin requirement) minus (Amount of investor equity left in margin account)
Here’s the formula using the hypothetical investor example above:
$500 = ($6000 x 0.25%) – ($1,000)
Investors can also calculate the share price at which he or she would be required to post additional funds.
Margin call price = Initial purchase price times (1– borrowed percentage / 1– margin requirement percentage)
Again, here’s the formula using the hypothetical case above:
$33.33 / share = $50 x (1 – 0.50 / 1 – 0.25)
In other words, the price per share cannot fall below $33.33 or the investor will risk getting a margin call.
Again, margin funds must be repaid with interest as well as any other transaction fees, which may impact these calculations.
How to Cover a Margin Call
When investors receive a margin call, there are only two options:
1. They can deposit cash into the margin account so that the level of funds is back above the maintenance margin requirement. Investors can also deposit securities that aren’t margined.
2. Investors can also sell the securities that are margined in order to meet requirements.
In a worst case scenario, the broker can sell off securities to cover the debt, without notifying the investor.
How Long Do You Have to Cover a Margin Call?
Brokerage firms are not required to give investors a set amount of time. As mentioned in the example above, a brokerage firm normally gives customers two to five days to meet a margin call. However, the time given to provide additional funds can differ from broker to broker.
In addition, during volatile times in the market, which is also when margin calls are more likely to occur, a broker has the right to sell securities in a customer’s trading account shortly after issuing the margin call. Investors won’t have the right to weigh in on the price at which those securities are sold. This means investors may have to settle their accounts by the next trading day.
How to Avoid a Margin Call
The best way to avoid a margin call is to avoid trading on margin or having a margin account. Trading on margin should be reserved for investors with the time and sophistication to monitor their portfolios properly and take on the risk of substantial losses. Investors who trade on margin can do a few things to avoid a margin call.
• Understand margin trading: Investors can understand how margin trading works and know their broker’s maintenance margin requirements.
• Track the market: Investors can monitor the volatility of the stock, bond, or whatever security they are investing in to ensure their margin account doesn’t dip below the maintenance margin.
• Keep extra cash on hand: Investors can set aside money to fulfill the potential margin call and calculate the lowest security price at which their broker might issue a call.
• Utilize limit orders: Investors can use order types that may help protect them from a margin call, such as a limit order.
The Takeaway
While margin trading allows qualified investors to place bigger trades using funds borrowed from the brokerage; but margin also amplifies losses. Margin calls occur when the value of securities and cash in an investor’s account fall below the level required by the brokerage firm.
Investors can then deposit cash or securities to bring the margin account back up to the required value, or they can sell securities in order to raise the cash they need (or the brokerage will do it for them, if the shortfall isn’t covered within a few days).
If you’re an experienced trader and have the risk tolerance to try out trading on margin, consider enabling a SoFi margin account. With a SoFi margin account, experienced investors can take advantage of more investment opportunities, and potentially increase returns. That said, margin trading is a high-risk endeavor, and using margin loans can amplify losses as well as gains.
FAQ
What happens if you cannot pay a margin call?
If you cannot pay a margin call, your broker will likely liquidate other holdings in your account to cover the shortfall.
Can a broker sell my stocks without warning?
Yes. If you’re unable to restore the maintenance margin in the account to the desired level, your broker can sell other securities in the account to make up the difference.
How is a margin call calculated?
Generally, when the balance in a margin account dips below the 25% maintenance margin required by the broker (or whatever that percentage is), it triggers a margin call. Here’s how a margin call is calculated:
Margin call amount = (Value of investments X percentage margin requirement) – (Amount of investor equity left in margin account)
What is a Fed call vs. a house call?
A Regulation T margin call, or fed margin call, is when an investor buys securities and doesn’t have enough equity in the account to meet the 50% or higher initial margin requirement. A house margin call, or maintenance margin call, is when an investor’s account balance dips below the 25% or higher minimum requirement. Either type of shortfall requires the investor to deposit cash or marketable securities (or the broker may do it for them).
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
Trading securities on margin loans involves high risk and costs and is not suitable for all investors. It is possible to lose more than your initial investment when using margin. Please see more details at https://www.sofi.com/wealth/assets/documents/brokerage-margin-disclosure-statement.pdf
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