Elements for a Margin Account
A margin account is a brokerage account that allows investors to buy securities using borrowed money from their broker. Securities in a margin account are placed as collateral on the margin loan. Using a margin account, investors still need to contribute certain amount of their own cash capital. The term margin refers to investors' own equity as a percentage of the total market value of the securities in the margin account. The margin, or the equity percentage, fluctuates over time as the market value of the securities change. Brokers require that the margin be maintained at certain levels in different situations.
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Initial Margin
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Initial margin may refer to both the equity percentage required when taking out a margin loan and the absolute dollar amount of the cash equity needed to initially open a margin account. For non day-trading margin accounts, many brokers require a minimum of initial cash deposit of $2,500. In the United States, the Federal Reserve sets the initial margin of the equity percentage relative to the margin loan. The initial margin is 50 percent each time investors borrow against their available cash equity. For example, with $2,500 initially deposited, an investor may borrow up to another $2,500 to buy securities for a total value of $5,000. If over time the value of the securities increases to $6,000, total equity becomes $3,500, and the additional $1,000 equity allows the investor to borrow another $1,000.
Maintenance Margin
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Maintenance margin is the required amount of equity as a percentage of the total market value of the account securities during the time when a margin loan is outstanding. Over time in market trading, as prices of securities fluctuate, the amount of equity in the margin account rises and falls as the amount of money borrowed remains the same. The lower the amount of equity in the account, the higher the chance that a broker may not be able to get its loan back by selling account securities. Maintenance margin is always set below the initial margin of 50 percent. In the U.S., the Financial Industry Regulatory Authority suggests a minimum maintenance margin of 20 percent. But many brokers set their maintenance margin higher at between 30 to 40 percent for increased safety.
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Margin Calls
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Margin calls are official notices sent out to investors of margin accounts when the amount of equity in their accounts has fallen below the required maintenance margin. After receiving a margin call, investors have certain amount of time to bring the amount of equity back to the level of the maintenance margin. Investors may deposit cash or securities into their accounts. Cash deposited directly reduces the amount of margin loan outstanding, resulting in a higher equity percentage. Securities deposited increase the total market value of the account, bringing up the equity percentage while the amount of margin loan remains the same.
Minimum Margin
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Minimum margin is the minimum dollar amount of equity that investors must maintain in their margin accounts while a margin loan is outstanding. The Federal Reserve requires a $2,000 minimum equity. Investors must watch both the minimum equity requirement and the maintenance margin requirement. When the equity amount drops below $2,000 even though the maintenance margin remains satisfactory, investors will receive margin calls that often are more urgent usually with less time given to investors to make any cash deposit. Any unmet margin calls lead to broker's requesting investors to immediately pay off all outstanding margin loans through selling securities in the account, leaving no chance to investors for future recovery when the market rebounds.
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