A Margin Call occurs when the value of the investor’s margin account drops and fails to meet the account's maintenance margin requirement. An investor will need to sell positions or deposit funds or securities to meet the margin call. If the investor fails to cover the margin call within 3 trading days, Firstrade will have to liquidate their positions to meet the margin call.
Here’s an example of how a Margin Call occurs:
You have $20,000 worth of securities bought using $10,000 borrowed and $10,000 in cash. When the margin requirement is 30% and the value of the securities drop by 40% to $12,000, since the amount you borrowed from your broker stays at $10,000, your own equity becomes $2,000 which is lower than the 30% minimum margin requirement.
$2,000 / $12,000 = 16.6% < 30%
A margin call occurs when the percentage of the equity in the account drops below the maintenance margin requirement.
How much is the margin call?
$12,000*30% = $3600 → amount of equity you were required to maintain.
$3600 - $2000 = $1600 → You will have a $1,600 margin call.
When a Margin Call occurs, you may either deposit funds or liquidate part of the positions you purchased on margin to cover the margin call.
By depositing funds you decrease the amount of margin and increase your equity. When you deposit $1,600 of cash into your account, your new account balance consists of $3,600 of cash and $8,400 of margin.
$3,600/($3,600 + $8,400) = 30% → reached margin requirement.
By selling stocks, you decrease the amount of margin, therefore increase the percentage of the equity.
Below is the calculation:
X = the amount of stocks you should sell to cover the call.
[($10,000 - X) + $2,000] * 0.3 = $2,000
($12,000 - X) * 0.3 = $2,000
$3,600 - 0.3X = $2,000
$1,600 = 0.3X
X = $1,600/0.3 = $5,333.3 → reached margin requirement.
In general, if you would like to deposit funds, the amount has to be equal to the margin call amount. If you choose to liquidate your stocks to cover the call, the amount you have to sell should be equal to the margin call amount divided by the minimum maintenance requirement.
$1600/30% = $5333.3
→ To maintain the 30% minimum margin requirement, you will need to either sell $5,333.3 worth of securities or deposit $1,600 worth of cash within 3 trading days, or Firstrade must liquidate your positions.
How can I avoid a Margin Call?
- Try not to use up your entire Margin Buying Power.
- Avoid a concentrated portfolio by diversifying your positions.
- Avoid trading on margin in highly volatile securities.
- Constantly monitor your account.