What Is a Margin Call?

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• A margin call occurs when the equity in your investing account drops to a certain level and you owe money to your brokerage firm.
• Margin calls must be satisfied by depositing cash or securities into the account, or by selling off assets.
• Using margin can increase the potential return but also magnify your losses.

Defining a margin call 

A margin call occurs when the value of the equity in your brokerage account falls below a certain level. This level is known as the margin requirement, and if it is crossed, it means that the investor is required to deposit more money into the account, add more marginable assets, or sell off some of the investments. 

In other words, a margin call is a demand that you increase the equity in your margin account to sufficient levels through one or more transactions. 

"The best way to describe a margin call is that you owe your investment platform or brokerage money," says Robert Farrington, founder of The College Investor.  

Within the context of investing, buying on margin is the practice of taking a loan from the brokerage firm for the purpose of purchasing stocks and other assets. Margin can increase the buying power for an investor by allowing them to make larger investments and generate higher potential profits. 

"Margin is an incredible tool to provide investors with access to additional capital," says Dr. Hans Boateng, founder of The Investing Tutor. "It works wonders in an upward market. It becomes dangerous in a downward market if you don't have savings in the event of a margin call."   

There are different types of margin calls and requirements based on what kind of account you have and the type of asset that you are trading.  Regardless of the account type or what you may be investing in, once a margin call has occurred, you'll be required to bring the account back to the minimum through the methods mentioned previously. If the margin call is not met quickly enough (usually between 2 to 5 business days) then your brokerage may sell out of your positions, which could result in a taxable event.

There are three main types of margin calls: maintenance margin calls, Regulation T calls, and minimum equity calls. Each of these margin calls can be triggered for different reasons. Here's a breakdown of each below.

Maintenance margin call: A maintenance margin call refers to the margin requirement to stay in a position. Once you have met the initial margin requirement of 50%, the Financial Industry Regulatory Authority (FINRA) requires that brokerages set a maintenance requirement of at least 25% for the remainder of the trade and allow brokerages to be even more restrictive. This is sometimes known as the "house requirement" and most brokerages set their maintenance requirements between 30 to 40%. 

Let's use an example where you have $10,000 invested in company ABC: If your brokerage sets the maintenance margin requirement at 25%, it means that the equity in your account must not fall below $2,500. 

Remember, a margin account will consist of the equity, which is the amount of cash you have, plus the amount that was loaned to you. Therefore, the total account balance would have to be $7,500 to receive a margin call ($5,000 margin loan + $2,500 remaining equity) because the value of the loan has not changed.

Here are a few scenarios using a 25% maintenance margin requirement with $5,000 in equity and $5,000 in margin. 

• If account value drops 10% down to $9,000 = No maintenance margin call
• Equity = $4,000
• Margin balance = $5,000

• If the account value drops 30% down to $7,000 = Maintenance margin call 
• Equity = $2,000
• Margin balance = $5,000
• You must now add at least $500 to the account 

• If the account value drops 40% down to $6,000 = Maintenance margin call 
• Equity = $1,000
• Margin balance = $5,000
• You must now add at least $1,500

Regulation T call: This type of call refers to the requirements needed to begin a margin trade and can occur when an investor makes a transaction in a margin account without meeting the initial 50% minimum equity requirement. This is sometimes referred to as a Fed Call.  

Minimum equity call: This is the lowest amount needed to open and maintain a margin account. This call — sometimes known as an exchange call — occurs when the account balance falls below $2,000 in equity. If you're classified as a pattern day trader, this requirement is $25,000.

Why margin calls happen 

Leverage

Margin calls can happen for a handful of reasons. One of the most common causes is borrowing too much. Traders who keep borrowing money to make trades can cross a line and end up going over their maintenance requirement, at which point they will trigger a margin call and need to increase the equity in their account. 

Market decline 

Another basic development that can trigger a margin call is a decline in the markets. If an investor buys an asset on margin, and then that asset falls in value, their broker will require them to increase the level of equity in their account. 

What happens if you can't meet a margin call? 

Potential liquidation 

If you fall below the maintenance margin, your broker can make a margin call. What happens if you ignore a margin call? Your broker can close out one or more of your positions in order to generate the needed equity. 

Some brokers will give you between 2 and 5 days to rectify the situation if your maintenance margin falls below the minimum. 

However, brokers generally have the ability to liquidate your positions if you fall below the maintenance margin. 

Potential costs 

If your broker liquidates one or more of your positions as a result of a margin call, this can cause you to incur losses on those positions. In addition, you may have to pay commissions on these transactions, and sales can also generate tax consequences, for example short-term capital gains that are assessed at higher rates than long-term capital gains. 

How to avoid margin calls 

Borrow conservatively 

One way to avoid margin calls is to simply limit how much you borrow. Just because you're given the ability to take out a large margin loan doesn't mean that you have to. If you're using margin, consider using less than the maximum amount — this would give you a larger share of equity and a bigger cushion to avoid a margin call. 

"The best way to avoid a margin call is to simply not use all your margin limit," says Farrington. 

Maintain a buffer 

Another way to avoid margin calls is to ensure that the equity in your account always stays above the minimum maintenance margin requirements. If you were driving a car, you wouldn't want to run out of gas, and in this case, the margin in your account is like the fuel you need to make leveraged transactions. 

You may want to keep cash on hand to give yourself greater flexibility to replenish your margin account. 

Monitor your account 

It is a best practice to avoid checking your investing account on a daily basis; however, this changes with a margin account due to the higher levels of risk. It may be wise to check your positions, as well as your equity levels, on a regular basis. You might also consider adding alerts that will let you know if the price of your securities fall within a certain range.  

Margin calls: Conclusion

Using margin in an investing account can help increase gains, but it can also magnify losses. It's important to make sure you're properly managing your risk.

 "There are really few reasons to use margin," adds Farrington. "It should only be used by experienced investors who have a specific plan and purpose for doing it. Maybe you're investing today while waiting for that ACH deposit next week. Or maybe you're executing a certain options strategy. But you need to have a specific plan."

As always, be sure to research your options thoroughly and consult a financial advisor or investment expert if needed.  

FAQs

Kevin L. Matthews II

Kevin L. Matthews II is a No. 1 bestselling author and former financial advisor. He has helped hundreds of individuals plan for their retirement in addition to managing more than $140 million in assets during his advisory career. In 2017, he was named one of the Top 100 Most Influential Financial Advisors by Investopedia. Kevin holds a bachelor's degree in Economics from Hampton University and a certificate in financial planning from Northwestern University. In 2020, he graduated from the University of Texas at Austin with a Master's in Technology Commercialization (MSTC).

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