By definition ‘A margin call is a situation in which a broker will demand more funds to be deposited in a margin account to increase the equity balance to the account minimum. In other words, it is a claim made by a broker in which the investor must increase his account balance to meet the minimum maintenance margin.’
A margin call happens when a broker demands that an investor deposits additional money or securities so that the margin account is brought up to the minimum maintenance margin. A margin call occurs when the account value falls below the broker’s required minimum value.
Basically, this means that one or more of the securities held in the margin account has decreased in value below a certain point. The investor must either deposit more money in the account or sell some of the assets held in the account.
What is a Margin Call?
The term margin call is common for intraday traders who are seasoned investors in trading through margin funding. For them, it is a warning call from their brokerage against investing any further in a particular stock or share facing a fall.
Investors use their demat accounts to trade using margin funding, where brokerages offer the ability to create a separate segment, within the account, that works as a margin account. Investors use margin funding to trade, where a percentage of the funds needed to purchase shares, are provided for by their broking agency, for a pre-determined interest rate. The purchased shares or stock also act as collateral against the funds being borrowed to purchase them. Investors also need to maintain the minimum threshold on their account known as maintenance margin. A margin call is triggered in case trades go south and your account’s equity balance falls below the maintenance margin.
Once triggered, the brokerage goes ahead with the course of action mentioned in the margin account agreement. The following action has two case scenarios. One, the broker calls the investor to notify him about depositing additional funds or liquidates collateral stocks to keep up with the maintenance margin and pay off the outstanding loan. The other course of action that the broker may undertake is to liquidate some of the positions held by the investor without notifying them. Here, proceeds from the sale are used to pay off the outstanding loans on priority. The amount left is credited back to the investor’s account.
Let’s take Adnan’s case into consideration to understand the concept a little better. Adnan has been earning for three years now and has been investing in the stock market to grow his accumulated corpus for two of those years. He decides to open his first margin account with Prabhudas Lilladher in order to invest more actively. He invested a total of INR 10,000 to open the account and borrowed INR 5,000 to begin trading with the sum total. The minimum maintenance margin set by Prabhudas Lilladher is 25% of the total account balance.
Several days of trading later, Adnan’s account was left with a balance of INR 6,500, which means he incurred a loss of INR 8,500. This triggered a margin call by PL since the equity balance of Adnan’s account fell below the minimum maintenance margin set by them, which in this case is 25 per cent.
Equity balance can be calculated by subtracting the funds borrowed from the total balance remaining, which in this case is INR 1,500 (INR 6,500 – INR 5,000) whereas the minimum required is INR 1,625. The call triggered will be to notify Adnan to deposit INR 125 to maintain the minimum margin threshold.
Margin trading is subject to market risks and must not be attempted by beginners. If you wish to foray into margin trading, it is recommended that you connect with our advisors at: PL India