What is Margin Call & How to Avoid It?
When the amount of money you have in your investment account falls below a certain level and you owe money to your trading firm, this is called a margin call.
When an investor receives a margin call, they must either replenish the account with cash or liquidate some of its holdings.
At what point will margin calls happen?
Margin calls can occur anytime. They are more common during periods of extreme market volatility. Here’s what triggers a margin call:
- You suffer a loss on the trade you hold, causing the value of your margin account to drop below the maintenance margin. A margin call occurs when the value of a trade you “short,” or bet against, increases or moves in the opposite direction.
- You’ll need to add funds to keep your account at the minimum required amount. Payment might be made in the form of cash.
- Your broker may force you to liquidate assets if you fail to deposit in response to a margin call.
Tips that could help you avoid a margin call
If you want to avoid a margin call, consider these below options.
1. Do not spend on borrowed funds
The simplest way to prevent a margin call is to invest only your money and never use borrowed funds for any purchase. Buyers are not obligated to utilize new accounts as margin accounts. Many brokers want to convert them to margin accounts immediately.
2. Using less than the maximum margin
A margin that is smaller than the maximum is another option. Brokers may permit investors to borrow up to half the deal’s total value but are not obligated to.
An investor may get some of the benefits of margin (greater buying power) with 10% borrowed funds, for example, but with a larger equity buffer.
3. You should avoid investing in risky assets
Well, you can also avoid margin calls if you don’t invest in high-risk equities. Margin calls are more common for stocks that experience large daily price swings, and the maintenance margin required can fluctuate quickly.
Investing in assets with inverse correlations can also mitigate the risk. However, even the correlations between unrelated assets can shift rapidly during extreme market fluctuations, such as the Global Financial Crisis.
4. Monitor your finances closely
Keeping enough equity in an investment account requires regular monitoring and the addition of cash, assets, or the sale of bonds.
5. Use leveraged ETFs
Consider leveraged ETFs as a further option. Fund managers use leverage to boost investors’ returns without exposing individual shareholders to the dangers of margin calls.
Bottom line
When preparing for long-term goal, like retirement, most investors avoid using margin. If you receive a margin call, you either increase your cash and asset deposits or liquidate some of your holdings to meet the minimum. Due to the increased frequency with which margin calls occur during periods of market volatility, you may be forced to sell trades at prices below your original purchase price.
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