There are many people who faced a margin call early this year when S&P 500 decreased by 26 percent. This forced some investors to liquidate positions for the purpose of satisfying the call. But it is important to note that some of the traders who experienced margin calls never borrowed money from their brokers.
As a trader, there are several things you need to understand about margin calls. This is because the stock market can sometimes be very unpredictable. If you have ever experienced the domino effect on a stack of cards, then that’s exactly what happens in the stock market from time to time. Markets can fall when you least expect. You can also read how to keep safe your online business.
According to the experts at SoFi, “Margin calls are demands for additional money made by the brokerage firm. Margin calls occur when the value of an investor’s trading account dips below a required level. In a cash account, all transactions are made with the funds investors have available. Meanwhile, in a margin account, investors can make trades with their own money and with money that is borrowed from their broker.”
Here are 5 things you should know about margin calls:
1. Margin Trading
It is important to understand that most of the buying and selling is done by traders. Retail traders constitute a very small part of the daily transactions in the stock market. However, most of the trades made are high in terms of value.
This means that it will be hard to access a lot of liquid cash to perform these transactions. This is where margin calls come in. You have the option of getting extra cash from your broker to carry out trades that the money in your account cannot.
2. Your Broker Has The Right To Change Margin Requirements At Any Time
Although there are regulations that set to limit the amount of money an investor can take, your broker has the power to demand higher or less margin compared to the regulated limits. Besides, they can change the terms of the margin to suit their needs. This basically means that you are at the mercy of your broker despite the fact that he is giving you extra money to trade.
3. Margin Math On Options Is Partly Driven By Fear
When a trader sells an option he or she gets immediate cash. However, you are also taking on an obligation with regard to the underlying stock. For example, if a trader decides to sell a $40 put option against a stock of $3, then you take that $3 but commit to purchasing the stock at $40.
4. Your Broker Can Decide To Liquidate Immediately Whenever You Face A Call
In most cases, a broker will give you a few extra days to satisfy a call. This is not always the case, especially when things become tense and chances of losing are eminent. In case a call is due immediately, your broker has a right to liquidate the money in your account to make you force you to comply with the margin limits without your permission.
5. Margin Call Selling
A margin call generally serves as an alarm bell for an investor to credit more cash into his or her account. This can happen at a time when you are not able to get that kind of money within a short period of time. In this case, your broker may decide to sell your shares to avoid losses.
In general, margin calls are good but there’s always a catch. You need to understand all the regulations and what a broker can do.