Investors who purchase many stocks but do not own sufficient funds or securities usually trade through margin trading. You can open a margin trading facility (MTF) with a broker, and the broker will lend you additional funds to purchase the desired stocks and levy an interest rate. Specific criteria are associated with a margin account, and you are required to maintain a percentage of the balance or a minimum balance. If you do not have the specified minimum balance, that is when the margin call comes into the picture. Keep reading to know what the meaning of margin call is and how you can avoid it.
What is a margin call?
The broker makes margin calls when equities in the MTF account falls below the maintenance margin. The MTF account contains securities bought with the money lent by the broker and the initial margin provided by the investor. A margin call indicates that one or more securities in your account have decreased, primarily due to market conditions. When the broker makes a margin call, you must deposit money in the account or sell a few securities to meet the maintenance margin.
Understanding margin accounts
Before you start margin trading, you must hold a Margin Trading Facility (MTF) account with your brokerage firm. This is different from a Demat Account. Essentially, you sign an agreement with the broker to meet certain marginal requirements. To do so, you need to know two terms - initial margin and maintenance margin.
Initial margin is the portion of a purchase that you, as an investor, will deposit in the MTF account with the broker before the actual purchase of stocks.
Along with the initial margin, investors need to maintain minimum equity in the account. The equity is the net value of your portfolio, i.e., the margin debt subtracted from the portfolio's value. [Equity = Net Value of Portfolio = Value of the Portfolio – Margin Debt]. Maintenance margin is the percentage of equity that is the market value of securities.
How do margin calls work?
Now that you are aware of the margin requirements understanding the margin call mechanism in trading is easy. Take a look at the below example that explains the margin call process.
For example, the broker sets the initial and maintenance margin as 50% and 25%, respectively.
You buy securities of Rs 10000, where the initial margin is Rs 5000 (50%), and the margin debt or broker-lent amount would be RS 5000. The maintenance margin would be Rs 2500.
But now the price depreciates by 40%, then the value of your portfolio will decrease to Rs 6000. Now the maintenance margin would be Rs 1500. (25% of Rs 6000)
Here, the equity would be Rs 1000 (Rs 6000 – Rs 5000). Since the maintenance margin should be Rs 1500, you must use all means necessary to raise Rs 500.
When the equity value falls below the maintenance margin, it is known as a margin call. If the equity falls to zero, the broker will not make a margin call but sell the securities held as collateral to recover the debt.
What happens if you get a margin call?
If you receive a margin call, you must ensure that you increase the equity in your MTF account. Today, the brokers notify you on margin calls via text or email. Once the margin call gets issued, you have a predetermined number of days to fix the issue. Investors should pay the debt and interest amount as per the signed agreement. The number of days will differ from broker to broker. Failure in doing will allow the broker to sell off your positions to recuperate the loan amount. If you wait and the prices fall even further, recovering the debt against the collateral would deem unobtainable.
How To Avoid Margin Calls?
Now you may ask, ‘Is margin call dangerous?’. If you haven’t taken the time to do proper research, then margin call can be very risky as it places a huge burden on your finances. Let us look at ways on how you can avoid it.
Ideally, brokers seldom make margin calls. All you have to do is, monitor your MTF account regularly and strategically plan your investments. If you are a novice investor, aggressively trading in margin calls may not be for you. You must time the market and get rid of stocks that are decreasing in value. Experienced traders know their way around the stock market and will make sure to minimise the losses by liquidating their assets before the broker makes a margin call. You can gather cash in a reserve account as a safeguard and deposit this amount in your MFT account when you suspect a market fall.
Usually, traders who buy and sell in the stock market form a large part of daily market transactions. Usually, these transactions are high-value transactions. Having instant access to such a volume of funds is challenging. Therefore, experienced traders borrow a percentage of capital from corporate brokerage firms. When transaction values are so high, poor market conditions can be detrimental to margin trading outcomes. Margin call in the stock market is the most undesirable term that traders or retail investors can come across on their trading journey. The market is bound to appreciate or depreciate. When the market is falling, margin traders must calculate their losses and find ways to avoid a margin call.
Are you looking looking to open a Demat Account? Click here to get started. HDFC Bank assists you to engage in the stock market with the utmost ease and comfort. You can open a Demat and Trading Account and avail of facilities that assist in margin trading, as well as currency and commodity trading. We assist in providing robust research services and enhancing your trading experience.
*Terms and conditions apply. This is an information communication from HDFC bank and should not be considered as a suggestion for investment. Investments in securities market are subject to market risks, read all the related documents carefully before investing.
