I was just reading up on trading, etc and found something called "margin-call". I understand it, and believe it to be that once your equity is too low, the margin call occurs and the trade closes, until the equity is high enough. I was just curious as to how these are enforce and how they are calculated. If one had, for example, $20 as a deposit, and they lost all of this, to end up with $5. What would the "margin-call" be? I'm just curious, because me and my parents never want to end up with a "margin-call" on our hands. Thanks.
Simplest way to answer this is that on margin, one is using borrowed assets and thus there are strings that come with doing that. Thus, if the amount of equity left gets too low, the broker has a legal obligation to close the position which can be selling purchased shares or buying back borrowed shares depending on if this is a long or short position respectively.
Investopedia has an example that they walk through as the call is where you are asked to either put in more money to the account or the position may be closed because the broker wants their money back.
What is Maintenance Margin? A maintenance margin is the required amount of securities an investor must hold in his account if he either purchases shares on margin, or if he sells shares short. If an investor's margin balance falls below the set maintenance margin, the investor would then need to contribute additional funds to the account or liquidate stocks in the account to bring the account back to the initial margin requirement. This request is known as a margin call.
As discussed previously, the Federal Reserve Board sets the initial margin requirement (currently at 50%). The Federal Reserve Board also sets the maintenance margin. The maintenance margin, the amount of equity an investor needs to hold in his account if he buys stock on margin or sells shares short, is 25%. Keep in mind, however, that this 25% level is the minimum level set, brokerage firms can increase, but not decrease this level as they desire.
Example: Determining when a margin call would occur. Assume that an investor had purchased 500 shares of Newco's stock. The shares were trading at $50 when the transaction was executed. The initial margin requirement on the account was 70% and the maintenance margin is 30%. Assume no transaction costs. Determine the price at which the investor will receive a margin call.
Answer: Calculate the price as follows:
$50 (1- 0.70) = $21.43 1 - 0.30
A margin call would be received when the price of Newco's stock fell below $21.43 per share. At that time, the investor would either need to deposit additional funds or liquidate shares to satisfy the initial margin requirement.
Most people don't want "Margin Calls" but stocks may move in unexpected ways and this is where there are mechanisms to limit losses, especially for the brokerage firm that wants to make as much money as possible.
Cancel what trade? No, the broker will close the position if the requirement isn't kept. Basically think of this as a way for the broker to get their money back if necessary while following federal rules. This would be selling in a long position or buying in a short sale situation.
The Margin Investor walks through an example where an e-mail would be sent and if the requirement isn't met then the position gets exited as per the law.
If you don't have a margin account, then you will not have margin calls.
You need a margin account if you wish to "buy on margin", to sell stocks "short", or to sell options, or maybe some other esoteric things I have not thought of. If you don't do those things, then you do not need a margin account and will not get margin calls.
In your example, it doesn't sound like margin has been used, If you deposit $20 and used it to buy $20 of stock and it then falls to $5, "they" did not lose the money, you did. But if no margin was used, then no margin call would result.