Imagine yourself as an investor. You want to invest in stocks so that you can make the maximum amount of profit imaginable. As an investor, you don’t want to invest too much but still have a leverage position.
But from a broker’s point of view, this possesses a risk. They don’t know if you will pay back the amount in case of certain situations. So this is quite a disadvantage for the brokers. To reassure that the investor will pay the amount, they have to keep a minimum amount in their margin account.
This amount has to be on hold after the purchase is made. The Financial industry regulatory authority declares that 25 percent of the total value of securities has to be set for each margin account.
- What Is Margin?
- Initial Margin and the Maintenance Margin
- How Maintenance Margin and Initial Margin Requirement Works
- What You Need to Know about Margin Trading
- Why is Maintenance Margin Necessary?
- Advantages of Margin Maintenance
- Risk of Margin Trading
- Strategies to Meet the Maintenance Margin
- Final Thoughts
What Is Margin?
When you buy a stock on margin, you mainly borrow money from your broker to buy more stocks. You use the stock as collateral. When you want to invest in the margin, you have to make sure that you meet the broker’s requirement.
The broker will only approve when you have enough balance in your account to initiate margin accounts. It’s how margin trading starts.
Initial Margin and the Maintenance Margin
As the name suggests, the initial margin is an investor’s amount in the account to initiate a trade. It is a margin that traders mainly use to place trades. On the other hand, the maintenance margin is the amount investor deposits to continue holding the trade position.
The relation between these two is that the initial margin is always higher than the maintenance margin. Maintenance margin is the minimum amount a trader needs to avoid the margin call.
How Maintenance Margin and Initial Margin Requirement Works
Maintenance margin is a niche subject that is not extensively talked about in the trading world. But we are going to dive deep to get all the nitty-gritty of maintenance margin.
Suppose you want to buy 100 shares of a company at 20 dollars for each share. But sadly, you don’t have the 2000 dollars in your account at the moment.
So, you can establish margin accounts that will allow you to acquire the stocks just by putting a percentage of the total price. This initial investment percentage is known as the initial margin requirement.
So what are maintenance margins? The maintenance margin is the amount that you have to hold in your account to avoid a margin call. Think of it like this. The maintenance margin requirement is 40 percent in case the stock of the company you are investing in has dropped 30 percent. As the stock has declined, the margin requirement will also reduce. So when the price drops, the percentage of equity of your total assets drops even more.
Also Read: How To Make Money In Stocks
What You Need to Know about Margin Trading
Maintenance margins are a crucial part of the entire margin trading. Margin trading has its share of risks. As we’ve mentioned before, it’s buying securities by borrowing stocks. You have the chance to make a lot of money in this process.
But when things start to go downhill, you will also feel the impact much worse. Let’s check out some of the things you need to know about margin trading.
Margin Account and Margin Contract
So, the first task of margin trading is opening margin accounts. It’s where you will put all your money. But before you open the account, your broker or exchange will get your signature on a few papers. Don’t get frightened. They are standard papers that talk about some requirements of the trading. By signing this, you accept a deal with the brokers on a margin agreement.
Make sure your broker doesn’t have rules that don’t fulfill the regulatory standards of margin trading in your country. Check the form carefully before signing. If the rules are not standard, then it’s a red flag. Each brokerage will have its interest rate. There will be repayment terms and specific conditions as well. By agreeing with the terms, you now are bound to follow the conditions.
Once you open the margin account, you have to put a minimum margin amount in the account to initiate. We already talked about the initial margins and maintenance margins previously.
The stock market fluctuates a lot. One moment there is a considerable uprise, and in the next moment, the market crashes. Even a single tweet from Elon Musk can create havoc in the entire financial market. Therefore you never know what’s coming.
By any chance, if the equity in your account declines below the Maintenance margin, the brokerage firm issues something called a margin call. This is pretty much like a wake-up call that indicates you have to compensate for the lack of funds in your account.
After getting the margin call, you have to deposit additional funds, provide extra collateral to balance the amount. Sometimes investors even liquidate their securities in response to a margin call. Usually, the maintenance margin is lower for most securities. But when the brokerage firm or exchanges have some risks, investors set the maintenance margin much higher. So, they have nothing to worry about.
Why is Maintenance Margin Necessary?
You may be asking if maintenance margin is a scheme that ensures the brokerage firm will get its money back. Well, that pretty much sums it up. It is a measure to protect brokerages and exchanges from investors defaulting from loans. An investor can borrow the money and vanish in thin air. What will the brokerage do then? Chase after the investor?
That’s why the margin maintenance ensures that the investors meet their end of the bargain after taking a loan. Apart from this, the maintenance margin acts as a buffer between the loan amount and the actual value of the account. This, in turn, decreases the inherent risks involving margin.
But the main question is how it helps the investors. Well, there’s a reason why maintenance margin and margin call exist.
Investors who trade in margins often encounter enormous losses and high gains. If these losses are not regulated or supervised, then it will create problems in the market. A snowball effect of gradual loss will occur. It will disturb the entire stock exchange and cause panic. Nobody wants that. Not the traders, and indeed not the investors!
Also Read: What is Margin in Forex?
Advantages of Margin Maintenance
Margin trading helps investors trade by borrowing money from brokerage firms. There are a lot of advantages of margin trading. It has become one effective strategy of modern-day trading.
When you trade in the margin, you have the opportunity to leverage the assets you own. By doing this, you can increase the amount of investment, which will give you high returns when the stock price rises. The Federal Reserve board has declared that you can borrow up to 25 percent of your total amount. No other strategy will give you this facility.
Profiting from Share Declines
This one is interesting. Once you have opened a margin account and met the requirement, you can start short selling.
Short selling is an investment strategy in which you borrow stock and sell them very quickly. Then, you can buy the stocks later when the price is much lower, which will help you get a substantial financial gain.
When your portfolio is diverse, you have fewer amount of things to worry about. If you have stocks from only one big company, then there is more chance of loss. In case the company’s overall shares decline, your entire portfolio will crash. That’s why it’s wise to diversify and have a wide range of options at hand.
With margin trading, you can use the loan to diversity your portfolio. The best part is that you don’t even have to sell your original stocks. You use your collateral stocks to invest in more options.
You have probably seen this scenario in movies. A person takes a considerable amount of loan from a bank to shape his company. But for some reason, he fails to pay it back on time. For this reason, the bank chases after him and ultimately puts him behind bars.
You don’t have to worry about such a situation in margin trading. As long as you don’t exceed the maintenance margin, you are fine. You can repay your loan anytime you want.
Like all other loans, the margin loans also have an interest rate. But they are not as high as others. The margin loans are associated with the federal fund’s target rate. Therefore they are regulated and supervised. It ensures that the interest rate is always standard.
In credit cards or bank loans, the interest rates are enormous. Sometimes paying the interest can leave you broke. Margin trading gives you reasonable interest rates that are easily manageable.
Participating in Advanced Options
You can trade in advanced options like spread, butterflies, ETFs, and indexes by opening a margin account. You can get all the information as well to become successful with each of them.
Risk of Margin Trading
While there are plenty of advantages, there are some risks associated with margin trading as well.
There is no doubt that margin trading allows you to make large profits. You can invest more and more by borrowing money from the broker. But when you suffer a loss, you feel the impact much more harshly. Margin trading magnifies the loss dramatically. So, make sure you think about this before investing in the margin.
Failure to Meet Margin Calls
If you don’t have enough equity percentages in your margin account, then the broker will issue a margin call. After receiving the margin call, you have to give additional fees and liquidate your shares to compensate.
If you fail to meet the margin calls, the broker can sell all the securities you own. They have the right to do so. Because in the contract, you agreed that if the amount doesn’t meet the maintenance margin, you have to face the consequences. So, the broker can sell your assets without you even knowing.
Strategies to Meet the Maintenance Margin
Always prepare for the worst. The market can change at any time. So monitor the volatility in the market. Position your assets in a way so that they can withstand market fluctuations. Therefore, even in market crashes, the value doesn’t fall below the maintenance margin.
Also, make sure you invest in stocks that have good return potential. If you invest in stocks with low returns, you will most likely fail to meet the maintenance margin.
Also, pay the interest of the loan regularly. If you neglect it, it’ll keep on piling up, and you will face the consequences in the end.
Maintenance margin helps build a good connection between the investor and the broker. The broker gets reassurance that the money is in good hands. On the other hand, the investor has less worry knowing that the loss and gains are regulated.
Therefore, the impact will not be too significant. If you want to become a great investor, there is no alternative to gaining knowledge about it. If you manage to stay above the maintenance margin at all times, nothing can stop you from earning high profits.
1. Is it mandatory to have the margin requirement in cash?
Yes, the margin requirement that an investor has to pay should be in cash. This margin can be further broken into initial margin and maintenance margin.
2. What amount of margin can be considered as safe?
You shouldn’t use more than 10% of your asset’s value as margin. It should always be moderated and only used in essential conditions. If you have to go higher, make sure to draw a line at 30%.
3. What happens if I can’t meet my margin call?
If you fail to meet the margin call, the brokerage firm is allowed to close an open position for bringing your account back up to the minimum requirement. It’s known as liquidation or forced sale.
4. How long can I hold a margin loan?
If you meet the requirements, you can hold a margin as long as you need. The primary requirement is paying interests on time.