Margin call: What it is and how to avoid one

Not quite sure what a margin call is? We'll help you learn the basics of this unfortunate financial event.

Last updated on January 28, 2023, and last reviewed by an expert on January 13, 2022.

Amargin call occurs when the value of securities in a brokerage account falls below a certain level, known as the maintenance margin, requiring the account holder to deposit additional cash or securities to meet the margin requirements. Margin calls only happen in accounts that have borrowed money to purchase securities.

Here are some other things to keep in mind about margin calls and how to avoid them.

What is a margin call?

A margin call may sound like the sort of thing that only happens to big players on Wall Street, but it can also happen to small investors who have purchased securities on margin, or using borrowed money. Here’s how it works.

If you’ve opened a margin account with a broker, it means that you’ll be able to purchase securities such as stocks, bonds and exchange-traded funds (ETFs) using a combination of your own money and money the broker has lent to you. The borrowed money is known as margin. This will allow you to trade more than you otherwise would be able to and will magnify your returns, either positively or negatively.

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One caveat to buying on margin is that you’ll also have a maintenance margin requirement, which requires you to maintain a certain percentage of equity in your account. When your portfolio falls below the maintenance margin, usually due to declining security prices, you’ll be hit with a margin call from your broker.

Once you’ve received a margin call you have a few options:

  1. Deposit additional cash into your account up to the maintenance margin level
  2. Transfer additional securities into your account up to the maintenance margin level
  3. Sell securities (possibly at depressed prices) to make up the shortfall

If you aren’t able to meet the margin call fast enough to satisfy your broker, it may be able to sell securities without your permission in order to make up for the shortfall. You will typically have two to five days to respond to a margin call, but it may be less during volatile market environments.

How to avoid a margin call

The easiest way to avoid a margin call is to not have a margin account in the first place. Unless you’re a professional trader, buying securities on margin is just not something that’s necessary to earn decent returns over time. But if you do own a margin account, here are a few things you can do to avoid a margin call.

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Margin call example

Let’s say you’ve deposited $10,000 into your account and borrowed another $10,000 on margin from your broker. You decide to take your $20,000 and invest it in 200 shares of XYZ company, trading for $100 a share. Your maintenance margin is 30 percent.

Minimum account value to avoid margin call = Margin loan/(1-maintenance margin)

In this example, if the market value of the account falls below $14,285.71, you’ll be at risk of a margin call. So if the stock price of XYZ falls to $71.42 or lower, you’ll be faced with a margin call.

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Let’s say Company XYZ reports disappointing earnings results and the stock falls to $60 not long after you bought it. The value of the account is now $12,000, or 200 shares at $60 per share, and you’re $1,600 short of the 30 percent margin requirement. You have a few options.

It should be noted that these are the minimum requirements to bring you back into compliance with the maintenance margin. If the stock continues to decline, you’ll need to put up additional equity.

It’s important to remember that the broker will be paid back in full for its loan and any losses are entirely yours. In this example, you deposited $10,000 of your own money and borrowed another $10,000 on margin. The account value declined to $12,000, leaving you with just $2,000 in equity and a decline of 80 percent, despite the stock only falling 40 percent.

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In reality, your broker may not give you much of a warning about a margin call and could even sell securities in your account without your permission or with no regard to tax strategies. Margin calls are often triggered during extreme market volatility and brokers may try to reduce their risk by calling in margin loans with little notice.

Summary

Buying securities on margin is not a good idea for most investors who are saving for a long-term goal such as retirement. A margin call will force you to boost your account equity either by adding additional cash and securities, or by selling existing holdings. Because margin calls often occur during periods of extreme volatility, you may be forced to sell securities at depressed prices.

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