What is buying on margin?
can you really buy on margin? Buying on margin involves taking a partial loan from one’s broker to cover a larger investment than one’s capital can directly cover. A margin call most often occurs when the actual capital invested by the investor falls below a set percentage of the total investment. A margin call can also be triggered if the broker changes their minimum margin requirement – the absolute minimum percentage of the total investment that one must have in direct equity. Some examples would best demonstrate the two circumstances under which a margin call is likely.
Suppose we go through our broker to buy $ 100,000 of stocks. We would say that we borrowed 50,000 from our margin broker to buy shares and invested $ 50,000 of our equity. After a particularly poor week of performance, the stock we initially invested in is now worth just $ 75,000. This leaves our equity of $ 25,000 that we can determine by taking the current value of $ 75,000 and withdrawing the loan value of $ 50,000. If our broker’s minimum margin requirement is, 30%, we will still be fine as the minimum margin requirement in our case would be 30% of $ 75,000, or $ 22,500.
But if the value of the shares falls again next day to $ 60,000, then our equity will be left at just $ 10,000. At this point, our broker will make a margin call and we will be forced to raise at least an additional $ 8,000. We could withdraw money to meet the margin call by selling off a portion of the stock we invested in by taking out another loan from another source or by refilling our equity pool with our own assets.
The second scenario where a margin call can occur is related to brokerage itself, rather than the execution of the market. Let’s assume the same situation as before when we bought $ 100,000 of stocks with $ 50,000 in equity. The same initial downturn happens, leaving us with $ 25,000 in shares on a $ 75,000 investment. The same brokerage has a minimum margin requirement of 30%, so they do not need to issue a margin call.
But sometimes due to the fluctuating market or internal factors, a broker may decide to adjust their minimum margin requirements slightly. If our brokerage was to raise their minimum margin requirement to 35%, the minimum equity would in our case be $ 26,250, so we would be issued a margin call and be forced to withdraw an additional $ 1,250. A margin call is not a big deal in the financial world and it does not reflect badly for an investor being the subject of one. Margin calls are simply part of a margin purchase, and while some people choose to keep their invested equity well above the minimum margin requirement to prevent a margin call, others keep investing at exactly the minimum, triggering a margin call. Every time the market goes down.