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Investor alphabet: what is margin call and how to avoid it



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When trading on the stock exchange, some investors prefer to use leverage. In this case, they take borrowed funds from a broker in order to increase potential profit. However, there are big risks and basically only experienced traders and investors use this tool.

One of these risks is a drawdown in the account, in which the client’s assets may not be enough to cover liabilities. In this case, margin call occurs. This is the requirement of the broker to stop trading from the account in order to avoid losses. Today we will take a closer look at this phenomenon, analyze examples and talk about how to avoid margin calls.

Introduction


It’s very easy to start investing on the exchange today - a brokerage account is opened online, you do not need significant amounts of money to buy many shares, derivatives or currencies. But it is difficult to get significant profit with minimal investment.

If you buy one share for a thousand rubles, which then grows in price by 50%, you will receive 500 rubles of income. In percentage terms, all this looks good, but in reality there will be very little money.

To circumvent this situation with a small amount of initial assets, so-called margin lending is used. Its essence is that the investor receives from the broker, in fact, a loan to make investments. In this case, the client must leave a deposit to secure the loan - it may be stocks, currency and other assets.

As a result, traders can make operations with stocks, currency, derivatives (futures, etc.), without physically owning them or without depositing the full amount of money needed to buy them.

It is clear that investing with borrowed funds is a rather risky activity in itself. Therefore, it is necessary to understand and what happens in case of unsuccessful developments in the market.

In the event that the price of shares or another instrument purchased with a margin loan does not go in the direction that the investor expected, or if the value of other instruments from his portfolio falls, the account balance may decrease too much. Then the broker sends the client the so-called margin call.

Margin call is a warning from the broker that the client’s funds are no longer enough to open new positions and provide current ones. Upon receipt of such a notification, the investor must additionally deposit funds to the account in order to restore the possibility of securing his transactions.

After a margin call, the broker can at any time forcefully close part of the positions at the expense of assets in the investor's account or IIA. This is necessary so that the value of the investor's liquid portfolio does not fall to zero and does not go into minus.

The broker has the right to close any positions on the account until the value of the liquid portfolio exceeds the amount of the initial margin and the indicator returns to the green zone.
In principle, this will happen when the value of the account or the equity of the account is equal to the minimum margin (MMR). This formula is expressed as follows:

= ( ) / (1-MMR)

Example:


Suppose you bought 10 Lukoil securities at your own expense.

Payment:

  1. March 6, 2019 Purchase of 10 Lukoil shares at a price of 5,500 rubles. The transaction amount is 55,000 rubles.
  2. March 12, 2019 Sale of 10 Lukoil shares at a price of 5,650 rubles. The transaction amount is 56,500 rubles.

Financial result: profit of 1,500 rubles.

Now suppose you invest in the same securities, but with a leverage of 1: 5. That is, you buy 5 times more securities:

  1. March 1, 2019 Purchase of 50 shares of Lukoil at a price of 5,500 rubles. The amount of the transaction is 275,000 rubles.
  2. March 6, 2019 Sale of 50 Lukoil shares at a price of 5.650 rubles. The amount of the transaction is 282,500 rubles.

Financial result : profit of 12,500 rubles.

With this profit, you need to pay the broker for the provision of leverage. You used the loan for five days at a rate of 13% per annum. It turns out that for the loan you owe 391.78 rubles (400 rubles).

Bottom line : the investor earned more than 12,000 rubles instead of 1,500 rubles.

Brokerage companies independently determine the rules for margin lending to customers. In ITI Capital, by default, all customers can trade with leverage if they have enough cash or liquid securities in their account.

What else is important to know


When conducting margin trading, investors are faced with restrictions. One of the main ones is the division of resources into different markets (stock, currency, urgent). In order to trade with leverage on each of them in a standard scheme, an investor needs to have assets to secure transactions in each specific market. This increases overall costs, plus overall not very convenient.

In order to get around this limitation, a single monetary position service ( UPL) is running in our MATRIx system . Within its framework, investors can work with a common account, which unites various markets. Assets that were purchased on one trading floor of the market can then be used as collateral in other markets from the list.

Conclusions: how to avoid margin call


Despite the fact that the use of leverage in trading can increase income, it is a risky tool. To avoid margin call and associated costs, you should follow simple tips:

  • If you conduct margin trading, you need to constantly monitor the market in order to control the balances of all accounts and deposit funds if necessary.
  • There is no need to increase losses - if the position does not work as it should and generates losses, it is better to close it.
  • It is necessary to quickly respond to messages from the broker.
  • Optimize the process - for example, using the service of a single monetary position, which allows you to reduce the cost of securing transactions in different markets.

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