A margin call takes place in situations where the security values in a brokerage account go under a particular level, called maintenance margin. This implies that the account holder would have to deposit additional cash or securities to keep up with the margin requirements. Remember that margin calls take place in accounts that have borrowed money to buy securities, and they typically take place in markets that decline quickly. Visit MultiBank Group
Understanding margin call
A margin call could seem like the kind of thing which only the bigger traders would have to deal with but this is a misconception. Even small investors who bought securities on margin or are operating with loaned funds could face a margin call.
Let’s say that you have started a margin account with your online broker, it would imply that you’d be able to buy securities like stocks, bonds, and exchange-traded funds (ETFs) with the help of a combination of your personal funds as well as the money you borrow from your broker. The money you borrow is called margin. This would enable you to trade with more funds than your finances would allow. This means that you’d get a chance to boost your profit or even your loss depending upon how the trade turns out.
A caveat while purchasing on margin is that you’d need a maintenance margin requirement, as per which, you will be expected to maintain a particular percentage of equity in your account. In case your portfolio slumps below the maintenance margin, which typically happens because of falling security prices, your broker would give you a margin call.
When you receive a margin call, here are a few steps you may take:
- Add some more funds to your account to meet the maintenance margin level
- Transfer another set of securities into your account to meet the maintenance margin level
- Sell securities probably at reduced prices to balance out the shortfall
If you’re not able to respond with action to the margin call as per your broker’s timeline, it would reserve the right to sell securities without your permission to be able to make up for the shortfall. Generally, a trader is given roughly two to five days to respond to a margin call, which could be even less if the market conditions are volatile.
What triggers a margin call?
If an investor uses their own funds in addition to borrowed funds from their broker to purchase or sell securities, it is said that the investor is buying on margin. An investor’s equity in the investment is the same as the securities’ market value, not taking into account the borrowed amount.
A margin call can be triggered if the investor’s equity, indicated as a percentage of the total market value of securities, declines and goes below the maintenance margin.
Margin calls could happen at any time but the probability is more in highly volatile markets. Here are a few factors that may lead to a margin call:
- Security you hold falls in value causing your margin account value to decline and go under the necessary maintenance margin. In case you short security, margin call might appear if the security doesn’t move in your favor and appreciates.
- You’d then have to add more capital into your account to match the maintenance margin level. The funds could either be cash or additional securities.
- In case you don’t add more funds, your broker would require you to make a sale to ensure the margin call is met.
How to avoid a margin call
The best and simplest way to avoid a margin call is to open a margin account at all. If you’re not a professional trader, purchasing securities on margin may not always be something which yields good results. However, should you have a margin account, the following things could help you avoid a margin call.
- Make sure you have additional cash available. It would help you meet the margin requirements should there be a margin call.
- It is a good idea to diversify your portfolio to bring down the impact of market volatility. Diversification would be handy when it comes to dealing with steep falls that could steer a margin call quickly. On the other hand, if you’re focusing too much on volatile assets, you’d be prone to sharp declines that may lead to a margin call.
- Keep close track of your account. Even though a majority of people do better by not checking their portfolio on a daily basis, if you have a considerable margin balance, it’s best to track it daily. It would help you be cognizant of your portfolio’s position and see how close it is to the maintenance margin level.
How to avoid a margin call
- Leave cash cushion in the account
Rather than investing all your funds in financial products, the investor could keep aside a set of cash deposits which could aid in avoiding margin calls. Cash provides a stable value and remains stable even if the security value fluctuates.
- Plan for volatility
An investor is able to diversify his/her portfolio by having multiple kinds of securities. The financial products could include stocks, bonds, commodities, and derivatives. A diversified portfolio could be useful for an fx trading investor when it comes to holding the ground in the face of unpredictable financial market fluctuations.
- Invest in assets with high return potential
High-return assets could be useful for investors in earning considerable returns in the short-term. Purchasing short-term assets which have the ability to bring high returns could enable the investor to earn enough return that pays off the margin loan and interest while still leaving room to earn profit.
- Make regular payments
Interest charges are levied on an investor’s account on a monthly basis. Given the fact that margin loans don’t have a particular repayment schedule, the investor must come up with a proper plan to pay interest charges as per the dues. When you pay regular interest payments monthly, it prevents loan accumulation to a great degree while also keeping the outstanding loan balance in check.