Margin trading involves purchasing securities with cash borrowed from a broker, offering equal prospects for both to make huge gains or equally huge losses. The securities are being used to guarantee the lending ( Also known as Collateral ). Hence, keeping track of the maintenance margin levels assures a way to mitigate this.
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What is Maintenance Margin?
Maintenance margin is the sum that must stay in the margin account to hold a trading position and avoid a margin call. It is the minimum equity an investor must hold in the margin account after the purchase has been made. It is currently set at 25% of the total value of the trade. The variance between the value of the shares and the loan refers to the net value, which is primarily equivalent to the amount of one’s own cash utilized. This gap must be greater than a minimum margin threshold, which covers the broker against a decrease in valuation of the shares to the degree that the borrower cannot cover the debt any longer.
How it is different from Initial Margin?
There is an initial margin, which is required at the time of the purchase. There is also a maintenance margin, which requires the minimum amount of equity needed in the margin account in order to keep the position open.
- A margin account permits an investor to buy stocks with a level of the cost covered by a credit from the firm.
- The initial margin speaks to the % of the purchase cost covered by the investor’s own cash and usually 50% min. of the funds in U.S. stocks.
- It is the minimum equity an investor must hold in the margin account after the purchase has been made.
- The higher initial margin limit is more pertinent, so utilized ETFs and call options are regularly better for investors who want more leverage.
Example of the Maintenance Margin:
Let’s assume you need to purchase 1000 shares of Company XYZ at 5$ per share yet you don’t have 5000$ required to do so. In that event you purchase the shares on margin, basically, you obtain the cash from the broker firm and collateralize the money with Company XYZ shares.
In the event if the shares drop, say 25% i.e. 1250$ (this is known as maintenance margin), a margin call will then be issued by the broking firms, implying within a specified timeframe you must deposit the cash or sell some shares in order to counterbalance all or part of the difference between actual stock price and maintenance margin.
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Investors benefit from margin facility as they allow for leveraged trading, which allows them to hold a higher price of securities by only depositing a fraction of the total value. However, in order to protect both the investor and brokerage financially, maintenance margins are critical for brokerage companies. These brokerage firms are secured by the maintenance margin from investors who default on their loans. The firm’s risk is minimized by maintaining a cushion between the loan amount and the account value.
Author – Priyanshu Ahuja
About the author – I’m a first-year student from City Premier College, Nagpur, pursuing BBA. My interest includes financial markets and the investment domain.