Margin Call is one of those stock market terms that are mostly incorrectly understood by traders and investors. Here is the information that helps you in understanding the margin call meaning.
In simple terms, the margin call occurs at the time when the margin account of the investor drops down or the amount in it fails to meet the maintenance margin requirements.
Here is a quick glance at various aspects of margin call that helps you in understanding its concept more clearly.
What is Margin Call?
Those who are involved in margin trading often remain doubtful about the margin call. Well, many among those do not even know exactly margin call meaning.
To begin with the concept, let’s first begin with the understanding of margin trading.
Margin trading is the process by which the trader is able to borrow funds from the brokers and use those funds to purchase securities.
This form of trading provides the traders with leverage to be able to buy more securities than they can otherwise afford at any point in time.
Even though the trader is borrowing funds, he has to pay some part of the total value of securities with his own money.
The part of the value of securities paid by the trader himself is called Margin Money.
A trader requires a margin account into which the money is to be deposited.
As soon as the margin account is opened, the trader needs to deposit some money into the account before he starts trading on margin.
This type of margin money is called the initial margin money, and minimum margin money. It is the fixed minimum amount that has to stay in the trader’s margin account throughout the trade.
This minimum amount allows the trader to borrow money from their respective broker to invest in stocks and other trading instruments.
One needs to maintain this minimum balance in their account. But when the money in the margin account starts going down and reaches below the minimum margin level, the broker made the dreaded Margin Call to the trader.
Margin Call meaning thus points towards the demand made by the broker to the trader to deposit additional cash or securities to his margin account so that the balance in the margin account reaches back the minimum margin requirement.
This happens when the trade has lost so much money that the broker fears that the trader will not be able to pay it off. It is a warning to the trader and protection to the broker.
The call may be a telephone call, like in older days, or the broker may just square off the trade to reduce the losses which leave the trader with more loss than anticipated as he did not get a chance to cover up for his losses.
In all, after understanding the margin call meaning you would realize that it is not a good situation and should always be avoided.
If a trader receives a call regarding the maintenance of a margin account, it means that the trader was unable to manage his trade properly and ended up in huge losses.
Margin Call Price
The margin call price is the stock price at which the investor receives a call from his respective broker.
The broker makes this call whenever the amount in the margin account goes down than the minimum balance maintained in it.
Thus margin call meaning is the demand made by the broker to the trader to deposit enough amount in the account in order to reach the minimum maintenance margin requirement.
Margin Call Formula
To keep the account at the minimum level, the investor needs to either deposit the additional funds or deposit the un-margined securities or sell their current position.
Here is the formula to calculate the margin call price:
Margin Call Price
= Initial Purchase Price x 1-Initial Margin/1-Maintenance Margin
Initial purchase price is the price at which the securities are purchased.
Initial margin is the minimum amount (in percentage) that the investor pays for the security.
Maintenance Margin is the equity amount (in percentage) that is essential to maintain the margin account.
Different brokers set a different minimum balance to avoid the margin call. For better understanding, you can use the margin calculator of the respective broker to understand the margin requirements.
However, the margin requirements change with the volatility of stock which is not calculated with the margin calculator.
Margin Call Example
Let’s make margin call meaning clearer by setting up an example.
A trader opens a margin account with an initial margin requirement as 8% and the minimum margin requirement is 4%.
He wants to buy 100 shares of Reliance Industries at ₹960 per share. So, the total capital required is 100*960= ₹96,000.
The trader deposits 8% of ₹96,000 = ₹7680 as an initial margin and starts trading.
The next day, the price of Reliance shares falls by 5%. In this case, the trade-off of 8%-5%= 3% is less than the minimum margin requirement of 4%.
At this point, a margin call is triggered to the trader by the broker and the trader must provide additional cash or securities worth 1% of the trade= ₹960 so that the margin account balance is able to reach back to the minimum margin requirement.
Thus as per the example,
Initial purchase price= ₹96,000
Initial margin= 8%
Maintenance margin= 4%
Putting this value in the margin call formula
= 96000 x 1-8%/1-4%
Thus, the trader will receive the margin call when the price of securities goes below ₹92,000.
Elaborating the explanation of margin call, it is interpreted that:
The investor purchased security for ₹96,000 using ₹7680 of his own and the remaining amount (₹88,320) from the broker.
The maintenance charges of the broker are 4% which means that the investor’s amount must comprise this 4% to maintain the minimum balance.
Margin Call in Forex
Here dig more to understand the margin call meaning in Forex.
A margin call happens when the trader does not have any usable margin in his account.
This generally happens when the account funding goes less because of the loss that occurred in trading.
Also, margin call occurs when traders use a large portion of the equity to used margin thus leaving a little room for facing loss.
The major causes that resulted in margin call are:
Holding a loss of trade for too long thus reducing the available amount in the margin account.
Trading with an underfunding account having too little usable margin.
Trading without stop loss even when the price moves in the opposite direction.
There are different ways that can help you to avoid margin calls in forex trading. Here they are:
Avoid over-leveraging your trading account. In general, it is good to use ten to one leverage.
Consider risk management by limiting the loss with stop loss.
Keep a good amount in a margin account to stay active in trade.
Do trading in small sizes.
Margin Call Finance
In finance, the margin is something that the account holder must maintain or deposit in their account in order to avoid certain credit risks.
In the margin account, the trader deposits amount in their margin account to make the better use of margin trading and use the fund effectively to trade.
If in case, at the time of revision of account, the broker finds the insufficient fund in investors’ account then he immediately places a margin call asking you to deposit enough amount in order to bring your account back into the line.
The investor can do so either by depositing the required amount, providing additional collateral or by disposing of some securities.
Margin Call Trading
The margin trading is something that plays a very crucial role in the stock market.
It helps various investors to invest in the market even though they are short of funds.
The margin trading allows the investor to invest in a small part while asking his respective broker to add the remaining amount.
Here, it becomes essential to have a minimum balance in the margin account to give assurance of the security of investment funds to the broker.
Also, the minimum balance in the margin trading account is used up in the case the share price goes down.
Thus, it is essential for the trader to maintain the minimum balance in the account to avoid certain consequences and losses.
In case the value falls below the minimum amount, the margin call is made by the broker to the investor to ask him to deposit more funds in order to continue hold on the position.
In case, an investor fails to fulfill the call requirement, the broker will more likely liquidate the position to grab his amount and to eliminate the margin call.
How to Avoid Margin Call?
As we have understood, a margin call is the last thing a professional trader will want to face.
It is mostly the result of a lack of knowledge and experience, and sometimes, due to the spontaneous emotions that the trader gets caught in. In order to avoid a margin call, a trader must:
Understanding the margin call meaning and its mechanism.
Knowing in detail the initial margin and minimum margin requirement of a broker before entering into a trade.
Depositing un-margined securities in order to meet the minimum balance requirement of the account.
Selling the margin securities in order to meet the account maintenance margin requirement.
Choosing to deposit a relatively higher value as the initial margin as compared to the value provided. This will assist you in keeping the difference between the initial margin and the loss percentage higher than the minimum margin percentage (like 8% we took in an example above).
Using stop-loss orders to ensure the losses do not go below the margin call level.
Managing emotions so that excessive greed and fear do not cloud judgment and force the trader to take huge risks and bear huge losses.
Margin Call Risk
Margin Call is taken very seriously by the brokerage firms, government, regulators and the traders. For the lenders, they serve as the protection mechanism against losses. The traders should avoid margin calls for the following reasons:
Margin Call meaning directs towards the unpaid debt. These unpaid debts are reported to credit agencies and may affect the credit score of the trader negatively.
The brokers may also file a lawsuit against the borrower in the event of non-payment of additional margin money, demanding immediate repayment.
So, the borrower, first of all, tries to avoid getting a margin call by trading efficiently, and in unavoidable circumstances of having received a margin call, the debt must be paid as soon as possible to avoid further damage.
For every investor who remains active in the stock market, it is essential to know the margin call meaning.
No wonder an investor always takes care of certain things to avoid the margin call.
The best way to get it done is to monitor the investment and to ensure that there is enough money in the margin account that can cover their maintenance requirement.
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