What is a Margin Call?
A margin call is a demand by a broker or lender for an investor to deposit additional funds or securities into their margin account. A margin account is used by investors to trade securities with leverage, meaning they can borrow funds from the broker or lender to trade a larger amount of securities than they would be able to with just their own capital.
If the value of the securities in the margin account decreases, the investor may no longer meet the minimum margin requirements set by the broker or lender. When this happens, the broker or lender will issue a margin call, demanding that the investor deposit additional funds to bring the account back up to the minimum required level.
Margin calls can be triggered by a variety of market events, including stock market declines, changes in interest rates, or other economic factors. If the investor does not deposit the required funds, the broker or lender may sell some of the securities in the margin account to bring the balance back up to the minimum requirement. This can result in significant losses for the investor, as they may have to sell their securities at a loss.
It's important to understand the risks associated with margin trading and to regularly monitor the value of your margin account to ensure that you are able to meet margin call requirements if they occur. Additionally, it's a good idea to only trade with a margin amount that you are comfortable losing.
Simplified Example
Think of a margin call like a bank loan for a big purchase. Imagine you want to buy a car, but you don't have enough money to pay for it all at once. So, you go to a bank and ask for a loan. The bank agrees to lend you some money, but only if you promise to keep a certain amount of money in your bank account as collateral.
Now, imagine that the value of the car you bought goes down. This means the value of your collateral in the bank account is also going down. If it goes down too much, the bank might ask you to either put more money in the bank account or sell some of the car to bring the value back up to what you promised.
This is what a margin call is – it's when a broker or a bank asks you to add more money to your account or sell some of your investments to make up for the decreased value of your collateral. Just like the bank is trying to protect its money, the broker or the bank is trying to protect its investment when it makes a margin call.
History of the Term "Margin Calls"
The term "margin call" has origins that can be traced back to the early days of organized financial markets, likely around the late 1800s or early 1900s. As margin trading, the practice of buying securities using borrowed funds, became more common, the need for a standardized term to describe the situation when a broker demands additional collateral from a margin trader became apparent.
Examples
Stock Market Trading: A margin call in stock market trading occurs when the value of a margin account falls below a certain level. If this happens, the broker may require the investor to either deposit additional funds into the account or sell some of their securities to bring the account value back up to the required level.
Foreign Exchange Trading: In foreign exchange trading, a margin call occurs when the value of a margin account falls below a certain level as a result of unfavorable market movements. The broker may require the trader to deposit additional funds or close out positions to bring the account value back up to the required level.
Futures Trading: In futures trading, a margin call occurs when the value of a margin account falls below the maintenance margin requirement. If this happens, the broker may require the trader to deposit additional funds or close out positions to bring the account value back up to the required level. Failure to meet the margin call can result in the forced liquidation of the trader's positions.