All About Margin Call

A margin call is an important concept in trading on margin, where investors borrow funds from brokers to buy securities. When the value of an investor’s holdings falls below a required threshold, the broker demands additional funds or securities to maintain the position. This is known as a margin call.

This article explains margin calls in detail, including how they occur, the risks involved, and strategies to prevent them.

When an investor’s margin account drops below the broker’s minimum requirement, the broker requires additional cash or securities to bring the account back to the required level. Margin trading boosts purchasing power but also heightens risk—if losses erode equity significantly, the broker issues a margin call to protect its loaned capital.

Here’s how margin trading operates and the key elements to keep in mind:

• Initial Margin: The upfront amount investors must deposit to open a leveraged position. This is often a percentage of the total trade value.
  

• Maintenance Margin: The minimum equity required to keep a position open. It is usually lower than the initial margin but varies by broker and asset.
  

• Leverage: Borrowed money that increases the size of an investment beyond the investor’s own capital.
  

If the market value of securities falls, the equity shrinks. Once it dips below the maintenance margin, a margin call is triggered.

Margin calls often arise from shifts in market value or leverage exposure. Here’s what typically triggers them:

Declining Stock Prices

When the price of stocks purchased on margin falls, the value of collateral drops, reducing account equity and triggering a margin call.

Increased Maintenance Margin Requirements

During volatile market conditions or regulatory changes, brokers may raise maintenance margin levels, increasing the likelihood of calls.

Excessive Leverage

Using high leverage increases exposure to price swings and raises margin call risk.

Sudden Market Movements

Unexpected market events or earnings surprises causing sharp price declines can quickly lead to margin calls.

Failing to meet a margin call can have significant financial and emotional impacts:

• Forced Liquidation: If investors do not meet the margin call by depositing additional funds or securities, brokers have the right to sell some or all holdings to restore margin requirements.
  

• Amplified Losses: Margin trading magnifies losses, which can exceed the initial investment.
  

• Loss of Control: Brokers can liquidate positions without investor consent to protect their loan.
  

• Increased Stress: Margin calls can create emotional pressure, potentially leading to poor decision-making.

Managing risk proactively helps reduce the chance of unexpected margin calls:

Maintain a Healthy Equity Buffer

Keep account equity well above maintenance margin requirements to cushion against market fluctuations.

Use Leverage Judiciously

Avoid excessive borrowing. Conservative use of margin reduces risk.

Monitor Positions Regularly

Keep track of market conditions and account balances to react promptly.

Use Stop-Loss Orders

Set stop-loss limits to automatically exit losing trades before equity falls too low.

Diversify Your Portfolio

Spread investments across sectors and asset classes to reduce volatility and risk.

Stay Informed About Broker Policies

Understand your broker’s margin rules and maintenance margin thresholds.

Imagine an investor buys shares worth ₹1,00,000 by investing ₹50,000 of their own money and borrowing ₹50,000 on margin. If the share price falls 20%, the total value becomes ₹80,000, and the investor’s equity drops to ₹30,000. If the maintenance margin is 30%, a margin call will occur because the equity is below the required amount (₹24,000 minimum in this case).

The investor will need to add funds or securities to meet the margin call or face forced liquidation.

Timely action and strategic adjustments can reduce the impact of margin calls:

• Respond Quickly: Deposit additional funds or securities immediately to avoid forced selling.
  

• Review Leverage Use: Reduce margin exposure if calls are frequent.
  

• Reassess Investment Strategy: Consider less risky investments or longer-term approaches.

Margin calls are a vital risk control mechanism in margin trading. While margin increases purchasing power, it also raises the stakes, requiring investors to monitor positions carefully and maintain sufficient equity. By understanding causes and applying prudent risk management strategies, investors can reduce the chances of facing margin calls and protect their capital.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.