Liquidation Margin
Buying securities on margin allows a trader to acquire more shares than can be purchased on a cash-only basis. If the stock price goes up, earnings are often higher because an investor holds more shares. However, if the stock price falls, traders may lose more than their initial investment.The liquidation margin is the value of all of the positions in a margin account, including cash deposits and the market value of its open long and short positions. If a trader allows their liquidation margin to become too low, they may be faced with margin calls from their brokers and the broker may liquidate those positions.
Margin Call
Definition
A margin call is the total value of all positions in a margin account, including cash deposits and the market value of open long and short positions. It ensures that traders can fulfill their trading obligations.
Origin
The concept of a margin call originated with the development of margin trading. Margin trading allows investors to borrow funds to purchase securities, amplifying their investment returns and risks. As this trading method became popular, margin calls were introduced as a risk management tool to protect brokers and market stability.
Categories and Characteristics
Margin calls are mainly divided into two types: initial margin and maintenance margin:
- Initial Margin: This is the minimum amount that a trader must deposit when opening a margin account, usually a portion of the value of the securities purchased.
- Maintenance Margin: This is the minimum account balance that a trader must maintain while holding positions. If the account balance falls below the maintenance margin level, the broker will issue a margin call.
Characteristics of margin calls include:
- Risk Management: By setting minimum margin levels, it limits the maximum loss a trader can incur.
- Liquidity Protection: Ensures that brokers have sufficient funds to cope with market fluctuations.
- Enforcement: If a trader fails to meet the margin call, the broker has the right to liquidate their positions.
Specific Cases
Case 1: Suppose Investor A deposits $1,000 in their margin account and borrows an additional $1,000 to purchase $2,000 worth of stocks. If the stock price drops by 10%, the value of their position becomes $1,800. If the maintenance margin requirement is $1,500, Investor A needs to deposit an additional $300, or the broker will liquidate part or all of the positions.
Case 2: Investor B holds $5,000 worth of stocks in their margin account and has $2,000 in cash deposits. If the stock price drops by 20%, the value of their position becomes $4,000. If the maintenance margin requirement is $3,500, Investor B needs to deposit an additional $500, or the broker will liquidate part or all of the positions.
Common Questions
Q1: What is a margin call notice?
A margin call notice is issued by the broker when the account balance falls below the maintenance margin level, requiring the trader to deposit additional funds to meet the minimum margin requirement.
Q2: What happens if the margin call is not met?
If the trader fails to meet the margin call within the specified time, the broker has the right to liquidate part or all of the positions to restore the account balance above the maintenance margin level.
