The Federal Reserve System Board and many Self-Regulating Organizations (SRO), such as NYSE and FINRA, developed a system of rules that regulate margin trading. Brokerage firms may establish their own requirements if they are in concordance with the rules of the Federal Reserve System Board and SRO.
Here’s what you need to know about margin types:
Before you start trading with margin, FINRA, for example, requires you to deposit minimum USD 2,000 to your brokerage firm or 100% of the buying price, depending on what is less. It is known as ‘minimum margin’. Some brokers may ask you to deposit more than USD 2,000.
According to Regulation T, approved by the Federal Reserve System Council, you have the right to borrow up to 50% of the buying price of the securities, which could be acquired on margin. It is known as ‘initial margin’. Some firms would ask you to deposit more than 50% of the buying price. You should also take into account that not all securities could be acquired on margin.
If a market is unstable, investors, who deposit initial margin for the stock, could, at times, be asked to provide additional money funds.
FINRA requires an investor, who bought the stock with margin, to have a certain amount of funds at any time.
According to the Rules, it should be not less than 25% of the total market value of the securities. These 25% are called the ‘position maintenance requirement’. In fact, many brokerage companies set even higher requirements to the maintenance margin amount – usually from 30% to 40%. Sometimes even higher – depending on what stocks the customer buys.
Let’s consider an example of how maintenance margin requirements act.
Let’s assume you acquired AAPL stock for the amount of USD 16,000, having borrowed USD 8,000 from your firm and paid USD 8,000 from your own funds.
Later, to your regret, AAPL rate falls. The market value of the stock you own goes down to USD 12,000. Your account balance will fall to USD 4,000 (USD 12,000 – USD 8,000 = USD 4,000).
- If your broker asks for 25% margin, you need to have USD 3,000 of your own funds (25% of USD 12,000 is USD 3,000). In this event, your funds are sufficient, since the available USD 4,000 is more than USD 3,000, which are required for servicing.
- However, if your maintenance margin brokerage requirements are 40%, you have problems. The broker needs your capital to be at least USD 4,800 (40% of USD 12,000 is USD 4,800). Your USD 4,000 capital is less than the minimum for maintaining your position in the amount of USD 4,800. In the result, a ‘Margin Call’ occurs, since the own capital on the account is USD 800 less than required.