Margin calls are a necessary evil in the world of investing. When an investor’s margin balance dips below a certain point, the brokerage will issue a margin call to let them know they need to deposit more money into their account or sell some stocks to cover their losses. Without this, then the brokerage may force liquidation of some securities.
What is A Margin Call?
A margin call is when an investor’s account falls below the maintenance requirement set by their broker. The latter happens if they have purchased securities on credit and are required to keep a certain amount of value in their brokerage accounts so that they can pay back loans taken out for these purposes, should it be necessary.
Without enough money in the account to maintain the required margin level, you will receive a margin call from the broker. According to SoFi, “Brokerage firms are not required to give investors a set amount of time.” The account holder must add more funds to their account or sell some of their securities. This is an integral part of investing that can cost investors big time if they ignore it.
Types of Margin Calls
The three types of margin calls are:
1. The Maintenance Margin Call
This is the minor type of margin call and generally occurs when an investor’s account balance has fallen under a specific percentage of its total liabilities. The brokerage, however, will not liquidate securities immediately in this case.
If they do that, it could cause their investment to fall even further than if they allow investors some time to fix the situation.
For example, an investor may have $20,000 in securities but only $15,000 left after a margin call because of losses on their investments. If they do nothing about this, the brokerage will not liquidate any securities until it falls below $12,500 or 50 percent of its total liabilities.
2. The Initial Margin Call
The initial margin call is a little more stringent than the maintenance margin call and occurs when an investor’s account is under a certain percentage of its total assets. Usually, this will result in forced liquidations, but it also gives investors time to fix the situation before things get too bad.
For example, if an investor has $25,000 worth of securities, but only $18,750 is left after a margin call because of losses on their investments, the brokerage will force the sale of some assets.
3. The Excess Equity Margin Call
This is the most severe type of margin call and occurs when an investor’s account falls below a specific percentage of its total assets. At this point, not only will some securities be liquidated, but all new trades on that security are prohibited until it rises above the required level. This can slow down or stop trading entirely in some cases, which won’t help the investor.
An investor should deposit more money into their account before a margin call occurs to prevent this from happening. Alternatively, they can reduce their risks by selling some of their securities to increase the value in their accounts. If they do nothing about it, it could result in even worse consequences, such as being forced to sell all of your assets. Similarly, you can be banned from trading for some time.