What is a margin call?

Margin Call Text on Financial Stock Market Graph — (Image credit: Getty Images)

When traders buy shares or other assets, they sometimes borrow money to fund the purchase. The aim of doing this is to increase their potential returns. Assume a trader buys £100,000 of shares and borrows £40,000 to do so. The shares go up by £6,000; they sell the lot and repay the loan. They are left with £66,000, a gain of 10% on the total capital they personally invested (£60,000), even though the share price only went up by 6%. Of course, it works the other way as well: a 15% drop in the value of the shares would mean that the trader has lost 25% of their capital.

The concept of using debt to fund part of an investment is known as gearing or leverage, but the specific practice of using money provided by a broker is known as buying on margin. The collateral that a trader must provide to protect the broker against credit risk (ie, the risk that they won’t pay back their debt) is known as the margin, and the amount borrowed is the margin loan. In our example, the trader has put up £60,000 in margin and has a margin loan of £40,000.

In reality, the collateral is not always new cash paid into the account: the trader may be able to borrow against other stocks. The amount of margin needed depends on industry regulations, the broker’s own policies, and the asset being traded (trading volatile small stocks needs more margin than trading stable large ones). Exchanges for trading derivatives such as futures set their own margin requirements and may raise these when volatility rises.

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The amount of collateral the trader must have before starting a trade is known as initial margin. The minimum value of collateral that must then be kept while the position stays open is the maintenance margin. If the value of the collateral drops below the maintenance margin level, the trader must pay in more collateral (known as variation margin) or their position will be closed. The demand for more collateral is known as a margin call.

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