Margin call

When investors buy shares or other financial assets, they might borrow money with the aim of boosting their returns. This is known as “leverage” or “gearing”, because using borrowed money amplifies movements in the underlying asset price, making both gains and losses far greater.  

You can view it as being similar to buying property with a mortgage. If you put down a 20% deposit on a £100,000 house, and the price rises by 10%, you’ve made £10,000, or a 50% return on your £20,000 deposit. If instead you had only put down a 10% deposit, you’d have made 100% – doubling your original £10,000. 

When an investor borrows to bet on markets rather than houses, they also put down a deposit. In this case, it’s known as “margin”. “Margin” is there to protect the bank or broker who is lending the money to the investor. If the bet goes the investor’s way, everything is fine. They may even be able to borrow more. But if the bet goes against them, then the cushion provided by the margin shrinks.

A “margin call” happens when the margin available to cover any losses falls below a certain level. At that point, the bank or broker demands the investor puts up more “margin” in the form of cash or other collateral, to cover against potential losses. If they fail to do so, the banks may force the sale of their holdings to reduce their own risk. 

Among private investors, spread-betters often get margin calls, whereby accounts are automatically shut once they fall to a certain level (this is a sign of poor risk management on the spread-better’s behalf). But it also happens to institutional investors, such as hedge funds. The risk is that if a heavily leveraged seller is forced to sell their shares, this can trigger margin calls on others, resulting in a domino effect. This is one reason why the Federal Reserve acted so quickly to underwrite the market during the early phase of the Covid-19 crash in March 2020.