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WIKI ANALYSIS| This article is part of WikiProject Definitions. Consider editing to improve it. View articles referencing this definition. |
This page describes leveraged security trading. For other types of margin, see Profit Margin.
Margin is a term given to borrowed money (and associated accounts) used to purchase securities. When an investor buys stocks, bonds, futures contracts, currencies, or other equities with this borrowed money, she is said to do so "on margin".
Functionally, margin can be thought of as a simple loan from a broker to augment one's position in a security. This requires, however, that a certain minimum of the investor's own money be available either in the investment or simply inactively held in the account. This minimum amount is generally some percentage of the loan total issued by the brokerage and is called the "margin requirement" or "minimum margin requirement". If the value of the investor's stake in the security falls below the minimum margin requirement, the brokerage will typically issue a #Margin Call or, in some cases, automatically sell off the security to recoup or prevent further losses.
Though each exchange sets the limits for margin transactions, brokerages offer margin buying to their clients at varying rates beyond the brokerage mandated limits, though never in violation of them. For example, an exchange may have a minimum margin requirement of 25%, but a brokerage might instead impose a 30% minimum margin requirement on its clients.
The size of the initial loan made by a brokerage is some percentage of the original money the investor puts up and is called the "initial margin requirement" or "initial margin limit". Typically the maximum balance a broker will allow to remain outstanding with such a loan is 50%. The reasons why this is common practice have their roots in the Great Depression, as excessive amounts of land-speculative margin debt (typically around 90% of the total value of the speculated land) combined with manifold concurrent margin calls have been cited as major causes Black Friday in 1929 and consequently the Great Depression. As such, somewhat more conservative margin limits have been imposed to prevent a similar catastrophe from reoccurring.
Margin debt is usually incurred with either the hope or expectation that subsequent increases in the stock's value will cover the remainder of what is owed to the broker, thus eliminating the buyer's debt (and possibly creating a profit).
Margin Call
Full article: Margin Call
A margin call occurs when the value of a client's leveraged equity (that purchased on margin) falls below the minimum margin requirement. The brokerage will literally call the investor and demand she put more money into her account, or risk losing the investment position altogether.
Example
- A trader wants to purchase 1000 shares of Company XYZ at $100 per share for a total of $100,000. His brokerage has a minimum margin requirement of 25%. He puts up $50,000 of his own money and his brokerage loans him the remaining $50,000 on margin. One month later, Company XYZ's stock falls to $90 per share. The trader is still okay, as his portion of the investment is still well above the the 25% minimum requirement ($90,000 total worth, minus $50,000 loan equals $40,000, which is 44% of $90,000). (Note, however, that a 10% decrease in stock price resulted in a 20% decrease in the trader's total stake.) Now, if Company XYZ shares fell further, say, to $65 dollars per share, the trader's total stake would be worth only $15,000 ($65,000 - $50,000 = $15,000), which is only 23% of the position's total worth. As such, the brokerage would either issue a margin call to the trader so that he could add sufficient funds to bring his total investment up to the necessary 25%, or else liquidate his account to recoup any losses.
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