Margin Call - Meaning, Process, and Prevention Tips

What are Margin Calls?

When the equity in a margin account falls below the minimum level required by the broker, a margin call is issued. The investor is then asked by the brokerage to deposit the account balance back. This may be done through additional cash deposits, securities deposits, or forced sales. It protects the broker's loan in case of unfavourable market trends. In mutual fund investments, margin calls do not feature, but in margin trading accounts, they can (investors use their own capital without borrowing the broker's money).

How Do Margin Calls Work?

A margin call occurs when the equity in a margin account gets reduced to such a level that it is below the required maintenance. In such cases, the brokerage asks the investor to add funds or securities to restore the account balance. 

Given that one share or unit is bought, the price at which the margin is called can be determined by using the formula given below:

Margin Call Price = Purchase Price × (Initial Margin − Maintenance Margin) ÷ (1 − Maintenance Margin)

Where:

• Purchase Price = Price at which the security was bought
• Initial Margin = Investor's own contribution
• Maintenance Margin = Minimum equity required by the broker

Example

An investor buys shares worth ₹10,000. They invest ₹5,000 and borrow ₹5,000. The initial margin is 50%, and the maintenance margin is 25%.

Margin Call Price = 10,000 × (0.50 − 0.25) ÷ (1 − 0.25)

= 10,000 × 0.25 ÷ 0.75

= ₹6,667

If the stock price falls below ₹6,667, a margin call is triggered. The investor must add funds, or the broker may sell the shares.

How to Avoid Margin Calls

Here's how you may avoid margin calls:

• Keep Cash Buffers: You need to have a little extra in your account that you can use to cope with highs and lows in the market. Cash acts as a buffer, so that it can be used to satisfy the margin requirements without necessarily selling investments.
• Diversify Your Portfolio: Invest in other types of assets, including stocks, bonds and commodities. Having diversification lowers the effect of the losses of any type of investment.
• Monitor Your Margin Account Regularly: Monitor your account regularly to observe movement in the equity. Early tracking enables you to add cash or change positions early enough.

Key Takeaways

The margin calls are normally triggered by a fall in price, volatility, or fluctuation in margin requirements. It is more helpful to have an idea of how margin calls are performed in risk management. This may be beneficial to reduce the risk of unexpected losses and to not have too much leverage, to track our account periodically, and to have some additional funds. Careful planning is central to safe and disciplined margin trading.