What is a Margin Call

It's the point where the value of your investment (including the money you borrowed) falls below the minimum level required by your broker, known as the maintenance margin. When these losses reduce the trader's margin to an important level, the broker demands that the trader deposit more funds into their account. This demand is known as a margin call.

Margin Trading

In margin trading, you can buy more securities than you could with just your own money by borrowing from a broker. This increases your potential for profit but also increases risk. If the market moves against your position, you can face losses. When these losses reduce your margin to a certain point, you get a margin call.

How a Margin Call Works

When you buy stocks on margin and the price moves unfavorably, your equity decreases. If it falls below a certain percentage, the broker will issue a margin call. Here’s an example:

Example:

• You have ₹1,00,000 in your account.
• You buy ₹2,00,000 worth of stock, borrowing ₹1,00,000 from your broker.
• The broker requires a maintenance margin of 25%.
• If the stock value drops to ₹1,20,000, your equity falls to ₹20,000, which is below the required ₹50,000 (25% of ₹2,00,000).
• You will receive a margin call to deposit ₹30,000 to bring your account back to the required level.

Formula for Margin Call Price

1. Initial Purchase Price: This is the price you paid for the stock when you bought it on margin.
2. Initial Margin: This is the percentage of the purchase price you had to pay upfront with your own money.
3. Maintenance Margin: This is the minimum percentage of the purchase price that you need to maintain in your account at all times. It's lower than the initial margin.

Here's a formula to calculate the Margin Call Price:

Margin Call Price = (Initial Purchase Price x (1 - Initial Margin)) / (1 - Maintenance Margin)

Avoiding a Margin Call

To avoid a margin call, consider these strategies:

• Keep Extra Cash:

Always have some extra cash in your account. This acts as an extra and prevents margin calls when the market is volatile.

• Diversify Your Portfolio:

Spread your investments across different assets (stocks, bonds, commodities). This reduces the risk of significant losses in any one area.

• Monitor Your Account:

Regularly check your account to stay aware of your margin levels and take action before reaching the maintenance margin.

• Set Personal Limits:

Determine a personal maintenance margin above the broker’s requirement. Add funds to your account when you approach this limit to avoid forced selling.

Conclusion

Understanding margin calls is essential for managing risks in margin trading. By keeping extra cash, diversifying investments, monitoring accounts regularly, and setting personal limits, traders can avoid margin calls and maintain healthy financial positions.

Example Table: Margin Call Scenario in INR
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In this example, if the stock price falls to ₹1,33,333, the trader would receive a margin call to add more funds to maintain the required equity.