Losses from Margin Calls

What is margin trading?

Margin trading allows an investor to buy more securities than you could with your own capital alone. Trading “on margin” means you’re investing with money you borrowed from your brokerage firm. For example, if you have $100,000 invested with your brokerage firm, you can offer those investments as collateral for a loan. Investors use margin accounts to leverage their investments and increase their purchasing power. While this strategy can amplify gains, it also exposes investors to higher levels of risk. 

How does margin trading work?

Here’s a brief overview of how margin trading works:

• Initial Margin: When you open a margin account, you’re required to deposit an initial margin, which is a percentage of the total purchase price of the securities you intend to buy.
• Maintenance Margin: Once you’re invested, you need to maintain a certain level of equity in your account, known as the maintenance margin. If the value of your securities falls below this threshold, you may face a margin call.

What is a margin call?

If the margin account’s equity drops below the maintenance margin level, a margin call will be made, forcing you to bring it back up to the required amount immediately. To meet the call, you must either deposit more funds or sell securities. Investors who cannot satisfy margin calls may have large portions of their accounts liquidated in order to satisfy the margin call. 

How do margin losses occur?

Margin losses can occur when the value of the securities purchased with borrowed funds declines. Brokerage firms charge a high interest rate on money borrowed on margin. If the market tanks and you lose the money you borrowed, you are personally liable to repay all of it, plus interest. Oftentimes, even if you make a moderate gain on your investments, you will still lose money due to the high interest rate.

Is margin trading a wise investment?

Margin trading is almost always a bad idea for the average investor. Every month your returns don’t beat the interest rate, your account goes down in value. As it does, you’ll have to continue to meet margin calls, and the returns you need to meet the interest payments will keep going up. In the worst-case scenario, you can end up losing your original collateral investment and owing a significant amount more in interest.

What are my broker’s responsibilities when it comes to margin trading on my behalf?

Brokers play a pivotal role in facilitating margin trading for investors. They have specific duties and responsibilities to ensure that their clients are adequately informed and protected. Some of those responsibilities include:

• Suitability Assessment: Brokers must consider factors such as the client’s financial situation, investment objectives, risk tolerance, and experience before recommending margin trading.
• Disclosure: Brokers must provide clients with comprehensive disclosures that outline the risks and costs associated with margin trading. These disclosures should be clear, concise, and easily understandable so that clients are fully aware of what they are getting into. 
• Margin Agreement: Brokers are responsible for having clients sign a margin agreement that outlines the terms and conditions of margin trading. 
• Maintenance Margin Monitoring: Brokers must continually monitor their clients’ accounts. They are responsible for issuing margin calls promptly and clearly communicating the necessary actions the client must take to meet the call.
• Authorized Trading: Brokers are expected to ensure that all trading in the client’s margin account is authorized and consistent with the client’s investment objectives and risk tolerance. 

What can you do if you feel your broker mishandled your account and you experienced margin losses?

A broker’s failure to properly disclose the risks associated with a margin account, or to follow a customer’s instructions not to trade on margin, can constitute grounds for recovery of associated losses. If you have concerns or questions about your broker’s handling of your margin account, consider consulting with an experienced investor rights attorney. We can review your investment history and documentation to identify any irregularities.