What is a margin call?
An investor’s margin account contains securities purchased with borrowed money (usually a combination of the investor’s own money and the investor’s own money borrowed from the broker). The broker will then ask the investor to deposit additional funds or securities to meet the minimum maintenance amount needed to continue trading. A Margin call occurs when the value of the investor’s margin account falls below the amount required by the broker, the funds are at risk of depletion, especially due to loss-making trading.
A margin call is usually an indicator that one or more securities held in margin accounts have fallen in value. When a margin call occurs, the investor must choose to deposit more money or margin securities into the account or sell some of the assets held in their account.
How can an escrow call be answered?
To overcome the margin shortfall, the trader must deposit cash or margin securities into an escrow account or liquidate some securities in the escrow account to partially pay the margin loan.
If an margin call is not met, then a broker can close any open positions to bring the account back to the minimum value. They can do this without investor approval. This means that the broker has the right to sell any stock, in the required amount, without letting the investor know. Moreover, the broker may also charge a commission to an investor for these transactions. This investor is responsible for any losses in the process.
How to manage the risks associated with margin trading?
Risk management measures related to margin trading include:
- Use stop losses to limit losses
- Keep the amount of leverage at a manageable level
- Borrowing for a diversified portfolio to reduce the likelihood of a margin call, is significantly higher with a single stock.
- The best way for an investor to avoid margin calls is to use a stop protection order to limit losses from any equity position, in addition to keeping enough cash and securities in the account.