Margin Call: What it is and How to Handle it

“A margin call is like a fire drill. It’s a drill for what you should have done before you started.” – Joel Greenblatt

In this blog, we will explain what a margin call is and how it can affect your business.

What is a Margin Call?

A margin call occurs when the value of an investor’s margin account falls below the broker’s required amount. When this happens, the broker will require the investor to deposit more funds into the margin account to bring it back up to the required amount.

Margin accounts are often used by investors to buy stocks, bonds, and other securities. These accounts allow investors to borrow money from the broker to invest in these securities. However, there are requirements for how much the investor must deposit into the account, to begin with, as well as how much they must maintain in the account to avoid a margin call.

What triggers a Margin Call?

A margin call is triggered when the value of an investor’s margin account falls below the broker’s required amount. This can happen when the value of the securities in the margin account declines, causing the equity in the account to fall below the required margin level. The margin level is the percentage of the total value of the securities in the account that must be maintained as collateral.

For example, let’s say an investor has a margin account with a balance of $50,000 and they have purchased $100,000 worth of securities. If the broker requires a minimum margin level of 50%, the investor would need to maintain at least $50,000 in equity in the account to avoid a margin call.

If the value of the securities held in the account falls to $80,000, the investor’s equity in the account would be $30,000 ($80,000 – $50,000). This is only 30% of the total value of the securities held in the account, which is below the broker’s required margin level.

As a result, the investor would receive a margin call and would need to deposit additional funds into the account to bring the margin level back up to the required level or sell some of the securities held in the account.

How does a Margin Call work?

Let’s say that you have a margin account with a balance of $10,000, and you decide to invest in $20,000 worth of stock. This means that you have borrowed $10,000 from the broker to make this investment. The broker may require you to maintain a minimum balance in the account of $8,000, which means that you need to have at least $2,000 of your own money in the account.

If the value of the stock that you invested in begins to decline and the value of your margin account falls below the required minimum balance, you will receive a margin call. This means that you will need to deposit more funds into the account to bring it back up to the required minimum balance.

Example of a Margin Call

Let’s say that an investor has a margin account with a balance of $20,000, and they decide to use that account to purchase $40,000 worth of stocks. The broker requires a minimum margin level of 50%, which means that the investor needs to maintain at least $10,000 of equity in the account.

If the value of the stocks that the investor purchased begins to decline and the value of the margin account falls below the required minimum balance, the investor will receive a margin call. Let’s say that the value of the stocks falls to $30,000, which means that the investor’s equity in the account is now $10,000 ($30,000 – $20,000).

However, this is only 33.3% of the total value of the stocks held in the account, which is below the required minimum margin level of 50%. As a result, the broker would issue a margin call, requiring the investor to deposit additional funds into the account to bring the equity back up to the required minimum balance of $10,000. If the investor fails to meet the margin call, the broker may liquidate some or all of the securities in the account to cover the shortfall.

How to Cover a Margin Call?

If you receive a margin call, you will need to cover the shortfall in your margin account by either depositing additional funds or selling securities held in the account. Here are some options for covering a margin call:

1. Deposit additional funds: You can deposit additional funds into your margin account to bring the equity back up to the required minimum level. This will allow you to maintain your current securities holdings and avoid having to sell them to cover the margin call.
2. Sell securities: You can sell some or all of the securities held in your margin account to raise the necessary funds to cover the margin call. This may be necessary if you do not have sufficient cash available to deposit into your margin account.
3. Reduce your margin exposure: You can reduce your margin exposure by selling some of your securities or refraining from purchasing additional securities on margin. This will lower your required minimum margin level, reducing the likelihood of future margin calls.

It’s important to note that if you do not meet a margin call, the broker may liquidate some or all of the securities in your account to cover the shortfall. This can result in significant losses and should be avoided if possible. It’s always a good idea to monitor your margin account regularly and to have a plan in place for covering potential margin calls.

How to Avoid a Margin Call?

Here are some tips to help you avoid a margin call:

1. Monitor your margin account: It’s important to keep a close eye on your margin account and monitor the value of your securities holdings regularly. This will allow you to anticipate potential margin calls and take steps to avoid them.
2. Maintain a healthy margin level: To avoid a margin call, it’s important to maintain a healthy margin level. This means keeping your equity in the account above the minimum required margin level set by your broker. A margin level of 50% or higher is generally considered a healthy margin level.
3. Be cautious with margin trading: Trading on margin can be risky, so it’s important to be cautious and not take on more margin debt than you can afford. Don’t use margin to purchase highly speculative stocks or to engage in short-term trading strategies.
4. Diversify your portfolio: Diversifying your portfolio can help to reduce your overall risk and minimize the potential for losses. This can help to reduce the likelihood of a margin call.
5. Have a contingency plan: It’s always a good idea to have a contingency plan in place in case you do receive a margin call. This could involve having cash reserves set aside to cover potential margin calls or having a strategy for selling securities in the event of a margin call.

By following these tips, you can help to minimize the risk of receiving a margin call and protect your margin account from losses.

Why are Margin Calls Important for Founders?

Margin calls are important for founders to understand because they can have a significant impact on your business’s financial health.

➡️If your business has investments in the stock market or other securities, you may have a margin account that is subject to margin calls.

➡️If your business receives a margin call, you will need to deposit additional funds into the account to avoid the broker liquidating your investments. This can be a significant expense for your business and can impact your cash flow.

➡️Additionally, margin calls can be a sign that your investments are not performing as well as you had hoped. This can be a signal to re-evaluate your investment strategy and make adjustments as necessary.

➡️In summary, a margin call occurs when the value of an investor’s margin account falls below the broker’s required amount. As a founder, it is important to understand how margin calls work and how they can impact your business’s financial health.

➡️By being aware of margin calls and staying on top of your investments, you can help ensure the long-term success of your business.

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