Updated Feb 09, 2022

What is Margin Call?

What is a Margin Call?

Margin accounts let investors borrow money from the brokerage and use that money to buy stocks. Margin accounts are also needed if an investor wants to short stocks because shorting means borrowing shares with the promise of returning them one day, which is why margin accounts are essential. You can have a margin account as long as you don't borrow money or stocks from the brokerage. But if you borrow money from the brokerage, you'll have to pay interest on that money, and you could get a margin call at some point, too.

Understanding Margin Calls

A margin call is when a brokerage tells an investor that they need to deposit cash, move in eligible securities, or sell stocks and securities to raise a certain amount of money in a few days. In most cases, a margin call is made when the value of the securities in the account drops, which means the investor's equity is lower. There is a "margin call" when an investor's equity in their margin account falls below the brokerage's "maintenance margin," as well as regulations and exchange rules.

Working of a Margin Call

Margin calls are driven by a ratio between investor equity, defined as all of an investor's assets, less any borrowed money, and asset value. Any deviation from the brokerage's minimum maintenance margin (and any applicable regulatory/exchange requirements) will result in a margin call.

For Instance:

The fact that an investor with 10,000 INR in their funds holds 20,000 INR worth of shares suggests that they borrowed 10,000 INR from the brokerage to purchase that stock. Equivalent equity is equal to half of the securities' market value (i.e., 10,000 / 20,000).

The margin call is a notification from the brokerage to inform the investor that their account capital has fallen below a specified threshold and that the investor must deposit a minimum sum of money or securities into the account, as well as sell following stakeholders in it, to minimise the margin liabilities within a given timeframe. If the trader meets the call, the situation is settled until and unless the proportion of account capital to account value continues to drop in the long term.

What If the Investor is unable to meet the Margin Call?

Suppose an investor cannot meet a margin call and perhaps refuses to do so. In that case, the brokers have the option to market all equities in the account ("liquidation" or "forced sale"), as well as every other account the investor may have with that brokerage, to make up the difference between the two amounts. Investors have no control over what securities are sold or at what price the brokerage decides to sell them.

How to avoid a Margin Call

Eliminating a margin call is as simple as not buying stocks with borrowed money and keeping purchases to the amount of cash in the banking account of purchase. Even though many brokers prefer to set up accounts as margin accounts, investors are not obligated.

They are using a margin that is smaller than the maximum is a possibility as well. An investor is under no compulsion to employ borrowed capital if a broker allows them up to half of the transaction cost. Even with a higher equity cushion, borrowing 10% of the total amount would still offer investors some of the margin advantages (increased purchasing power).

Suppose you're trying to prevent margin calls. In that case, you may want to steer clear of speculative commodities, which are more susceptible to margin calls and might even be prone to unexpected changes in sustaining margin needs. If you want to minimize exposure, you can own inverse proportion assets, but the concern here is if these connections can alter quickly in situations of substantial market upheaval. Maintaining a healthy level of equity in one's account is an essential part of one's investment strategy, and investors must keep an eye on their portfolios.

Conclusion

With an account balance, traders can take loans from the brokerage to boost their purchasing power by taking more significant holdings with the money they already have. If an investor's account balance falls below the minimum, the stockbroker or authorities may require additional shareholder deposits in an attempt to reach their credit lines. Suppose a trader seems unable to meet the required capital requirement. In that case, the broker has the authority to sell off the holdings and penalise the account owner with additional charges, penalties, and interest.12