A margin call is a broker's demand for an investor to deposit additional cash or securities into a margin account. When you borrow money from your broker to purchase securities—a practice called buying on margin—you must maintain a minimum equity level in the account. If your account value drops due to declining security prices, your broker will issue a margin call requiring you to restore the account to the maintenance margin requirement. Failure to meet this demand within the specified timeframe results in forced liquidation of your positions at potentially unfavorable prices.
How It Works
When you open a margin account, your broker sets an initial margin requirement (typically 50% of the purchase price) and a maintenance margin requirement (usually 25-30%). As the value of your securities fluctuates, your equity percentage changes. If it falls below the maintenance requirement, the broker issues a margin call. You then have a few days to deposit funds, sell securities to raise cash, or deposit additional collateral. If you don't act, the broker automatically liquidates positions to bring the account into compliance—often at the worst possible moment for your portfolio.
Why It Matters for Investors
Margin calls represent significant risk, particularly for angel investors and entrepreneurs exploring leveraged investment strategies. They force you to make rushed financial decisions, potentially crystallizing losses and disrupting your overall investment thesis. Additionally, forced liquidations can trigger substantial tax consequences and destroy the diversification of your portfolio. Understanding margin mechanics is essential if you use leverage to amplify returns, as market volatility can quickly turn profits into urgent demands for capital.
Example
Suppose you deposit $100,000 and use margin to buy $200,000 of stocks (50% margin requirement). Your account equity is $100,000. If the stocks decline 30% in value to $140,000, your equity drops to $40,000—only 28.6% of the position value. If your broker requires 30% maintenance margin, they issue a margin call. You must either deposit approximately $2,000 in new capital or sell securities to meet the requirement immediately.
Key Takeaways
- A margin call forces you to add capital or collateral when account equity falls below maintenance requirements.
- Forced liquidation often occurs at unfavorable prices and can generate unexpected tax liability.
- Understanding leverage and margin requirements is critical before borrowing to invest.
- High-net-worth investors using margin should maintain substantial cash reserves to weather market downturns without facing margin calls.