Maintenance margin is the total amount of capital that must remain in an investment account in order to hold an investment or trading position and avoid a margin call. To better understand what a maintenance margin is, it’s important to review the underlying concepts of margin accounts and margin calls.
Breaking Down Maintenance Margin
Before the maintenance margin can be fully understood, it’s important to understand what margin accounts are and how they work, which involves maintenance margins.
A margin account is a trading account that is leveraged – i.e., a trader does not need to put up the total value of an investment in order to hold a trading position. Instead, they are only required to make a deposit, called margin, which is a fixed percentage of the total value of the financial security they are making an investment in. In essence, the remaining value of the investment is borrowed from the brokerage or other investment firm the trader is using.
The government regulates minimum margin requirements for leveraged trading accounts. In addition, each brokerage or trading firm sets their own margin requirements in accord with such regulations. A brokerage firm’s minimum margin requirements often exceed the government required minimum margins. It provides the brokerage firm and its clients with extra financial security.
Initial Margin and Maintenance Margin – How It Works
To understand how margin accounts operate, and how maintenance margin comes into play, it helps to look at an example.
Consider a trader is looking to purchase 100 shares of Company ABC at $20 per share, but the investor doesn’t have the needed $2,000 needed to purchase the entire amount of those stocks. If the investor has established a margin account with his or her brokerage firm, they may acquire the stocks by only putting up a percentage of the total purchase price. This initial percentage is referred to as the “initial margin requirement.”
For our example, let’s assume that the initial margin requirement is 50% of the total purchase price, which, in this case, is $1,000. In order to acquire the full 100 shares that the investor wants, he or she would need to have at least $1,000 in their trading account to meet the initial 50% margin requirement. When an investor buys on margin, they are essentially borrowing the balance of the total purchase price from their brokerage firm, for which they typically are charged a minimal financing fee.
The maintenance margin is the required percentage of the total investment that is less than the initial margin, and which the investor must maintain in their trading account in order to avoid a margin call – a demand from their broker that they either deposit additional funds into their account or liquidate a sufficient amount of their holdings to meet the margin call. For our example, let’s assume the maintenance margin requirement is 40%.
Now, let’s assume that the value of Company ABCs stock drops by 30%. The trader’s margin account will have then fallen below the maintenance margin level, as outlined below:
The total value of the 100 shares of ABC stock has declined to $1,400.
The value of the investor’s 50% margin requirement has declined from $1,000 to $700.
The 40% maintenance margin level is $800.
Therefore, the investor’s account has fallen $100 below the required maintenance margin level.
Once the above occurs, the brokerage firm sends a margin call to the investor. It means that the brokerage firm notifies the trader that he must do one of two things: put more cash into the account or sell off some of the shares in order to make up for the difference between the stock’s current price and the maintenance margin requirement.
In the event of a margin call, the brokerage firm may require the investor to deposit additional funds or liquidate sufficient securities to bring the account back up to the initial margin requirement of 50% of the original total value of the investment.
Margin accounts are helpful to investors because they enable leveraged investing – the ability to hold a larger total value of investments by only having to deposit a percentage of the investments’ total value. Before a margin account is established, all involved parties must sign all the appropriate agreements that outline the government regulations on margin accounts, as well as the brokerage firm’s own requirements for trading on margin. Maintenance margins are important for brokerage firms because they protect both the investor and the brokerage financially.
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