What is a Margin Call?
A margin call can occur when your broker asks you for money you’ve lost on an investment position. You previously invested with leverage (aka you borrowed funds to pay for part of your investment), and now your deposit needs ‘topping up’.
Investing on margin means making a deposit in your brokerage account and borrowing the rest of the money from the broker for the investments. But when markets move against your position (aka you lose money on your position), you may have to top off that deposit.
A margin call is your broker calling for you to top off that margin as a result of the losses your position is making. To be sure, your position here means the amount of a security, commodity or currency you own.
Similarly, profits on your position come in the form of margin deposits back into your account (aka money coming your way.)
Trading on margin is available for most stocks, bonds, foreign exchange (forex) and futures trading. However, it is not always available for certain ineligible securities classes or certain types of otherwise-eligible securities due to pricing or volatility issues. The borrowing itself is called leverage or gearing. A margin is like the security pledged against that. If you’re losing money, your broker can – and will – ask for more of that security.
Margin calls are based on account, not a single holding. This means that if the value of one stock went to zero, but all other stocks were fully paid for, there may be no margin call.
As an example of margin, imagine you buy $2,000 worth of stock but only put up $1,000 of that margin, or security – a 50% margin or 2x leverage. The margin can either be in the form of cash or other securities like stocks or bonds. Your $2,000 purchase is now paid for by your $1,000 cash paid on the transaction plus the $1,000 your broker has lent you. The broker is lending to you against the security of those bonds or stocks.
Now, say the market moves against you and you begin losing on the transaction. Your $2,000 in stock purchase is now only worth $1,800. You could think that you've only got to add in $100 as the margin call but this would be incorrect. You've got to put in $200. Your margin call will be the total loss on the position, not just the half of it that is being financed.
Another way to put the same point. You spent $2,000 on the stock you bought. It is now worth $1,800. You owe $1,000, that 50% of the original financing to the broker. You thus have $800 left of that initial margin you put up. But you are still trying to finance a $2,000 position. The margin call is $200. The total loss on the position for the margin, plus the financing loan must be equal to the amount spent on purchasing that position in the stock at all times.
A margin call is when you made that bet with Billy...
If he ate the guppy, you’d buy the beer. He ate it, so now you’ve got to pay up. In other words, you lost so now it’s time to flash the cash.
Of course, a margin call is about investment, not a bet. But the same principle applies. You said if your investment was losing money, then you’d put more into your account if the broker called for it. They have, now you’re paying up.
Margin is the deposit you’ve put up against the borrowings you’ve made to finance your position. If your position is losing money, then you’ll need to put up additional deposits if your account goes below a certain minimum percentage of debt to value. Those lending you the geared part of the position aren’t going to risk their own money on your behalf. A margin call is, well, calling you to call in that extra margin.
One determinant of how much profit you make on an investment depends on the size of the investment. If you don’t have enough to invest, it is possible to borrow money to finance an investment position to potentially reap higher profits. Borrowing, however, comes at a cost. If higher profits can be reaped, losses can also magnify. Since lenders giving you money to gear up your investment don’t know that you’re going to make a profit, they ask for a margin — Some amount of your money in the financing equation.
Margin borrowing may not be suitable for all investors. The rules of margin borrowing are complex so It’s important that you fully understand your financial status because margin borrowing may affect your investments.
Margin borrowing increases your level of market risk, as a result it has the potential to magnify both your gains and losses. Regardless of the underlying value of the securities you purchased, you must repay your margin loan.
Most firms that extend margin credit can change their maintenance margin requirements at any time without prior notice. If the equity in your account falls below the minimum maintenance requirements (varies according to the security), you’ll have to deposit additional cash or acceptable collateral. If you fail to meet your minimums, your broker may be forced to sell some or all of your securities, with or without your prior approval.
To short sell means to sell something you don’t own in the hope of buying it back cheaper at a later time. When short selling a stock you must borrow that from someone who does own it. When you borrow money, you pay a premium. If your position moves into profit as the stock falls in price then great. But if the price rises, putting you into loss, then you’ll be getting those margin calls.
The risk here is that the amount a stock price can increase is theoretically unlimited, while a stock can only fall to zero thus limiting the upside. But it might do so long after you’ve already had to pay everything you can to cover the margin calls and have closed out your position as you cannot finance anymore.
It is possible to buy stocks on margin and expect that their price is going to rise, not fall. The regulations concerning margin trading are complex. (Click here to read more about them.) A useful rule of thumb is that you generally must finance 50% of the position directly and leverage the rest, though the rules are complex and depend on your specific circumstances. Margin calls will be made to ensure there is always this amount (50% of the position) available as that balance to that geared part of the financing.
It is possible to trade foreign exchange (forex) on very slim margins. Some platforms, may only 1% or even lower margin requirements. (Robinhood also supports margin investing.) While this may increase the opportunity for profits to magnify, a minor movement in the price of the currency paid being traded could wipe out margin completely, or even incur losses in excess of initial investment. If margin calls aren’t met, this will mean the investment is sold. That is, a total loss of the deposit, margin, put up at the time of the original investment.
A common enough connection is made between those two phrases although there isn’t actually one there. There are two different meanings of the word margin being used here. When applied to business metrics, ‘margin’ is an attempt to measure the success of a business by using margin calculations such as Gross Profit Margin (Revenue - Cost of goods sold / Revenue), Net Profit Margin (or (net profit / net sales) x 100), revenue to debt repayment (how large or small is the cost of paying off debts relative to the total amount of money coming in?) and so on.
Margin trading in financial markets is the amount that must be used as a deposit to finance a trading position.
In both, margin trading and margin in business metrics, you can think of margin as a ‘buffer'. Business margin calculations let businesses know if they’re making enough money to cover their expenses and continue their business activities. Margin trading tells investors/traders if they have enough money in their account to continue investment activities.
For example, if the gross profit margin of a business is zero, then it’s out of money. Similarly, in margin trading, if your margin is zero, you will have nothing left to continue trading.
It is possible for you to trade on margin in different markets, using varying amounts of leverage. Different markets will have different triggers for when margin calls are made. A rough and ready idea is that a margin call will demand that you provide sufficient cash or securities to maintain the prescribed ratio of debt to equity. Details of how a margin call is calculated will vary from market-to-market, sometimes even from broker-to-broker within the same market.
Binance is a private crypto exchange and market. Binance is unaffiliated with Robinhood, and investors should undertake their own diligence prior to choosing to invest or trade with Binance. Binance offers the ability to trade cryptocurrencies such as Bitcoin and Ethereum on margin. It is possible to leverage your trading position by providing security and borrowing the balance of the financing from the crypto exchange. This can be a useful example of the details of how margin and margin calls work.
Say, prices of the cryptocurrencies underlying your investment move against your position. Investment carries risk so this does happen. There is an equation to determine your margin level:
Margin Level = Total Asset Value / (Total Borrowed + Total Accrued Interest Rate)
If this margin level drops to 1.3, then you are likely to receive a margin call. That means you need to either deposit more funds or sell down at least a part of your position to raise that margin level in response to the call. If margin falls to 1.1, then the position will be liquidated and you will be sold out of that position.
The crypto market uses margin trading widely. Some exchanges offer very much higher leverage, the inverse of much lower margin requirements. The greater the leverage, the greater the potential profit. As is the possibility of loss and therefore you receiving one of those margin calls, and similar to other margin investing, you may owe more than your initial investment.
The risks of leverage rise, the more volatile the underlying instrument being traded. For instance, 10% of price movements in crypto are commonplace, 20% in a day not unknown. High leverage, say the 20:1 that some exchanges offer, might be taking on more risk than you’ll be happy with.
Margin trading involves interest charges and risks, including the potential to lose more than any amounts deposited or the need to deposit additional collateral in a falling market. Before using margin, customers must determine whether this type of trading strategy is right for them given their specifc investment objectives, experience, risk tolerance, and financial situation. 20191104-1001696-3026803
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