What Is a Maintenance Margin?
Maintenance margin is a term used in the financial markets to indicate the minimum collateral amount required to maintain an open credit (margin) position. Maintenance margin differs from initial margin in that the amount of money required to maintain a margin position is generally lower than the amount required to open the position initially. Margin requirements differ greatly between stocks and futures. Due to the increased leverage and volatility inherent in futures trading, futures investors may be required to meet maintenance margin calls as often as daily.
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Function
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The function of a maintenance margin is prevent catastrophic losses due to the over-extension of credit to investors. When a given position declines in value to a point where a margin call is issued, the investor is given the choice to add funds to the account to maintain the position or to close the position at a loss and eliminate the risk of further margin calls.
By their very nature, all futures contracts are purchased on margin. The various exchanges set the initial and maintenance margin requirements. More volatile futures contracts will have greater margin requirements. Due to the leverage involved in some futures contracts (as much as 20:1 in some cases), it is possible for the market to move against an investor enough for the investor to lose his entire initial margin and put the investor in the red; the investor then must add funds just to bring the account back to a zero balance.
Stocks aren't nearly as volatile, and there are more safeguards built into margin trading on stocks. For example, the initial margin requirement to buy (go long) stocks in a margin account is 50 percent, leveraging the position at a mere 2:1 rate. In other words, to buy $100,000 worth of XYZ on margin, the investor must open the position with $50,000 in cash or securities. In order to maintain the position, however, the investor is only required to add funds to the account when the overall value falls below 25 percent.
Effects
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Sometimes margin calls requiring increased maintenance margin have a severe effect on a stock. If the price of a stock has fallen very quickly and many investors own the stock on margin, a large percentage of the owners may choose to sell the stock instead of adding funds. This causes increased selling pressure on the stock, and creates a downward spiral of the stock price as more investors are shaken out by margin calls.
Considerations
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When an investor receives a maintenance margin call, he must decide whether to close the position or add funds to the account. If the investment continues to drop in value, he could be receiving margin calls day after day. Sometimes it is better to close the position and take the loss, allow the stock or commodity to find its bottom, and then re-enter the position at the lower price.
Benefits
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The benefits of trading on margin are the increased leverage margin trading affords. When used conservatively, the leverage margin trading affords increases gains exponentially. For example, a 10 percent gain in a stock's price equates to a 20 percent return on the same amount invested if the stock was purchased on margin.
Warning
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Margin trading is only for sophisticated investors, and investors must be approved by their brokerage firms to trade on margin. Since margin trading is an extension of credit, margin interest is charged in addition to regular commissions and fees. When trading futures, it is a good idea to have access to real-time quotes in order to close any position dropping fast enough to require a maintenance margin call.
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