If you have been in business for a while, chances are you have had to cover a margin call. This is an insight into the basics of a margin call and how to get one covered to avoid taking unnecessary debt.
What is a Margin Call?
Most new entrepreneurs wonder, “what is a margin call?” According to SoFi, “It is a demand for immediate payment of funds due to insufficient cash or securities in an account.” When the value of the trader’s position falls below the maintenance margin requirement, he will be issued a margin call.
A margin call refers to when the brokerage firm asks for more money or securities to meet minimum account requirements. This can happen if the value of assets in an account falls below a certain point, usually at least 25%. Your broker will make this request via phone or email, and you have some time to comply with it before they take enforcement action.
Understanding Margin Calls
If the value of your account falls below what you owe, a margin call will be issued to cover that deficit. You can meet this obligation by depositing additional cash or securities into the account.
The problem arises when you do not have the money available to cover a margin call. In that case, you might have to sell some securities in your account at a loss or take out a loan to meet this obligation.
When someone issues you with a margin call, they are asking for more money within usually 24 hours. If you don’t have any cash, selling some of your securities may be necessary or taking out a loan from another source. An enforcement action, like a forced sale or creditor seizure, might result if you do not comply.
Margin Call Formula
A margin call formula is a percentage of the margin (by value) a broker needs to keep an investor’s account within acceptable limits. If the margin call is greater than 0, it means that you are required to increase your equity or cash in your trading account.
The current market price would be subtracted from the maintained margin requirement and multiplied by 100%. If this number falls below 70%, the broker will issue a margin call to bring it back up.
If you have $20,000 worth of stocks and they are now valued at $15,000 due to market fluctuations, 70% of this would be -$1400 (70% x 15000). Your broker will then ask you to deposit $1400 cash or securities into your account. If this amount is not met within 24 hours, the broker may force a sale of assets for it to meet its minimum requirements.
The margin call formula calculates how much more money or equity an investor needs to bring their accounts back up aftermarket conditions have caused them to fall.
How to Cover Margin Calls
If you cannot cover a margin call or do not have time to meet it, the best course of action is usually to sell securities in your account. If this does not work, take out a loan from another source and deposit cash into your brokerage account. This will bring the value back up above what you owe so that no further enforcement action is necessary.
In summary, covering margin calls is about depositing enough cash or securities into an account to ensure that it meets minimum requirements. In case you don’t have funds, sell some of your assets at a loss to meet their minimum requirements.