Margin Call: What It Is & How to Avoid It
You have probably heard about an unpleasant surprise to traders: a margin call. And we hope you do not know how bad it might be for your money.
A margin call is a broker’s demand for a trader to increase their margin account’s value to a minimum balance set by a broker. Unfortunately, some who trade on margin have no clue about the related risks.
But as ominous-sounding as a margin call may be, the fear of it did not keep hungry traders from leveraging their portfolios. So let’s try to simplify this term that causes troubles to traders’ accounts and figure out what a margin call is and how to avoid one. Because forewarned is forearmed.
Key Takeaways
- Margin calls occur when a trader’s account value drops lower than their broker's required margin maintenance level.
- Traders can trigger a margin call by trading on high leverage with insufficient funds in their accounts.
- Margin calls usually happen during times of high market volatility or unexpected market movements.
- To meet a margin call, traders can deposit more funds or close out some positions.
- Traders can avoid margin calls by understanding the margin requirements, using Stop Loss orders, scaling in positions, and clearly understanding their trading strategy.
What a margin call is
A margin call refers to margin trading, a popular method among traders to increase their buying power and make larger trades. By opening a margin account, people can trade on margin, meaning they use their own money and borrow money from a broker to trade specific instruments. Margin trading can bring great profits but also magnify big losses.
“Using margin is great when the market moves as expected, but a margin call is awful.”
It comes with an inherent risk that traders must be aware of – margin calls, indicating that instruments held in the margin account have decreased in value. Simply put, a margin call happens when a trader's account value falls below the required margin maintenance level set by their broker.
Yes, every brokerage company has its minimum maintenance requirements that have to be met by traders while trading on margin. Some brokers have a greater minimum maintenance level than others, with some demanding as much as 30–40%. FBS requires 40% of the minimum margin level to provide the most convenient conditions for its traders.
What triggers a margin call
Margin calls can be triggered by a number of factors, but the most common reason is trading on high leverage and using insufficient funds in the account. When traders use leverage, they actually borrow money from their broker to open larger positions.
However, leverage can work against traders during high market volatility, economic uncertainty, or drastic price changes, leading to crucial losses that can quickly deplete their account value.
The wrong and poorly built trading strategy can also trigger a margin call.
When a margin call happens
Margin calls usually happen during high market volatility or sudden price movements. News, events, economic reports, or other factors can cause the market to move abruptly. Yet, margin calls can occur anytime.
Traders who use high leverage and do not have sufficient funds to cover their losses are more likely to receive a margin call during volatile market hours.
How to meet a margin call
If a trader receives a margin call, they should meet it immediately but no later than the specified due date, which commonly varies from two to five days.
To meet a margin call, traders have two options:
- Deposit additional funds into an account. Depositing more money can increase the account value and bring it back above the required margin maintenance level.
- Close out some positions. Closing out some orders can help reduce the overall risk and prevent further losses.
When a margin call occurs, the trader must choose to either deposit additional funds or close some of the positions opened on the account. Otherwise, a broker can close out enough of your positions to bring your balance back into compliance, sometimes without notice.
Traders who have met a margin call can contact their broker to determine the due date and possible solutions. By the way, FBS has 24/7 multilingual customer support ready to answer clients’ questions.
How to avoid a margin call
If you don’t understand the margin trading concept and how a margin call works, you will likely experience the shock of your account erupting.
But traders can prevent this damaging event. Here are some tips to avoid margin calls:
- Trade with clear understanding.
Before trading on margin, carefully consider whether you really need one. If you do, realize the sense of margin trading, volatility, and trading strategy and apply risk management techniques to reduce costly mistakes.
- Learn the margin requirements BEFORE you place any order.
Knowing all details, you can choose the appropriate leverage and ensure that you have sufficient funds to cover your trades. Plus, monitor your orders and margin balance regularly.
- Use Stop Loss orders or trailing stops.
Such orders can limit your losses and control your account value from falling below the required margin maintenance level.
- Scale in positions rather than entering all at once.
The scaling in means you start small and expand steadily: you open one mini order and then add more as the price moves in your favor, changing Stop Loss. Thus, you can reduce risks and choose suitable leverage.
With these tips, a well-built strategy, and constant learning, you may avoid margin calls in your trading path.
How to calculate a margin call: formula & example
Let's say a trader has a margin account with $20 000 and decides to buy 500 shares of XYZ stock at $50 per share. The total order cost would be $25 000 ($50 per share x 500 shares.)
Assuming the broker has a 50% margin requirement, the trader should put down $12 500 (50% of $25 000) and borrow the remaining $12 500 from the broker to complete the purchase.
If the value of XYZ stock falls to $40 per share, the total order value would be $20 000 ($40 per share x 500 shares) – equal to the initial balance in the trader’s margin account.
However, the trader still owes the broker the $12 500 borrowed to purchase the stock. Since the value of the investment has fallen below the 50% margin requirement, the trader receives a margin call from the broker to deposit additional funds or securities to bring the account back up to the required margin level.
To calculate the margin call amount, the broker uses the same formula as in the previous example:
Margin Call Amount = (Current Value of Securities in the Account x Margin Requirement) - Account Balance
In this case, the margin call amount would be:
Margin Call Amount = ($20 000 x 50%) - $12 500
Margin Call Amount = $10 000 - $12 500
Margin Call Amount = -$2 500
Therefore, the trader should deposit an additional $2 500 to meet the margin call and maintain their position in XYZ stock. If the trader fails to meet the margin call, the broker may liquidate some or all of the open orders to cover the outstanding debt.
How risky margin trading is
Trading becomes riskier when it comes to margin trading. With amplifying gains, it can also amplify losses. Using leverage can quickly wipe out a trader's account if the market moves against them. Additionally, margin calls can be stressful and difficult to manage in rapidly changing markets.
People who want to trade on margin should have solid market awareness and risk tolerance. It’s essential to carefully consider the risks of margin trading before starting it.
Bottom Line
Margin trading can be a lucrative way to trade and increase potential profits, but it comes with higher risks. Traders who want to trade on margin should understand markets, margin trading, and risk tolerance. Additional funds to meet a margin call in the case of one are also necessary. If traders receive a margin call, they should quickly meet the requirements and keep securities from liquidating.
