What is a "Margin Call"?

First off to receive a margin call, you must have a margin account.

A margin account, as compared to a cash account, is an account in which you are able to buy stocks on "margin". This means that you are able to buy stocks using your broker's money. If you had say, 2:1 margin, this means that if you had $10,000 worth of cash or securities in your account then your total "buying power" would be $20,000. This can obviously enhance your gains or magnify your losses.

Since you are using your broker's money to finance your purchases, they have what is called "minimum maintenance margin". The NYSE and the Nasdaq require your broker to maintain a minimum required level of 25% on all margin purchases, however your brokers will usually have a higher maintenance requirement, sometimes as high as 40%.

If you fall below this level, you will be hit with a "margin call". This is when your broker forces you to add more cash or securities into your account in order to maintain the minimum maintenance requirement. If you are unable to meet this "margin call", then your broker will sell off some of your positions for you in order to maintain the minimum maintenance levels. Obviously a margin call is not a good thing. The broker will give you some time to sell some of your positions or increase the amount of equity in your account - if you are not able to do this, then the broker will sell your positions for you.

The minimum maintenance requirement can vary depending on the customer or the firm. Again, this can vary from a bare minimum of 25% and go all the way up to 40%.

Margin can be a very effective tool in terms of maximizing your buying power and subsequently maximizing your gains. On the flip side, investing on margin can be dangerous if your positions start to go the wrong way. You always have the option of opening a "cash account" at your broker, which means that you are not given any buying power and can only invest what is in your account.

If you are going to be investing on margin, then make sure that you know what you are doing. You don't HAVE to use margin even if you have a margin account - there is something to be said for investing just what you have in your account. If you require the capability to buy on margin and you currently have a cash account, then contact your broker and ask them how you can switch.

Filed under: Stock Market Education | General Knowledge