Margin calls are among the most critical risk management tools that stockbrokers have at their disposal. Your broker will issue one out to you if your margin account balance falls below a certain threshold. Brokers refer to this threshold as the maintenance margin. If you are short on cash, it might get a bit frustrating or even dangerous. Here, we’ll go into the ins and outs of calculating margin calls.
What Are Margin Calls?
Margin calls are requests from your broker requiring you to add funds to your account or sell securities. In this way, they help to meet maintenance requirements for margin accounts. When a margin call is triggered, it means an investor borrows money to buy securities or assets. It uses them as collateral. According to the financial experts at SoFi, “A margin call happens when a brokerage firm says that an investor needs to add funds to their account.”
This is a percentage of your total account value that you must deposit into your account to open it. Your broker sets the initial margin, but it’s typically around 50% of your total investment.
The calculations your broker uses to determine whether or not you must add funds to your account.
Calculating Your Margin-Call Price Based On Volatility
Many investors are not familiar with how margin calls work. To ensure you don’t experience one, you must understand margin-call calculations. Simple ways to calculate your margin-call price include the following tools:
- Excel Template (Free Download)
The margin-call Price Calculator spreadsheet is a free download. This tool helps you calculate your margin-call price based on volatility, but brokers shouldn’t use it as an exact science.
- The margin-call Price Formula
The formula for calculating your margin-call price is: Initial Purchase Price x [(1 – Initial Margin) /(1 – Maintenance Margin)]
- The Online Calculator
An online calculator doesn’t just allow you to plug in your initial margin. It also includes your maintenance margin, current market price, and volatility. Of course, brokers should consider the number of shares as well.
- Other Online Tools
These online tools will calculate your margin-call price for you, but they may not be free to use. For example, the following tools will calculate your margin-call price based on volatility.
- Yahoo Finance (free)
- Bloomberg (paid)
- Investopedia (free)
- Interactive Brokers (paid)
- Morningstar (free)
After calculating your margin-call price, remember that these prices are fluid. In other words, they change based on market conditions. For example, if there is a decline in volatility or an increase in your portfolio’s value. This means your margin-call price will decrease.
What to Avoid When Calculating Margin Calls
Don’t use your gut when calculating a federal-margin call. When our emotions kick in, we try to skip some steps or shortcuts for time-saving. These small mistakes can cost you big.
Other Factors Necessary for Calculating Margin Calls:
- margin requirement
- trading level
- exchange rate
- the value of margin call
When investments lose value, they don’t cover the loan amount plus interest payments. Also, being too conservative or over-leveraging a position won’t help. There’s no one size fits all approach.
Make sure you correctly identify all positions in your account before calculating a margin call. Also, don’t try to apply blanket rules that cause you to take unnecessary losses.