What is a maintenance margin?
Searching for a maintenance margin definition? A maintenance margin is the minimum amount an investor must keep in their account after buying securities with money borrowed from a broker. This acts as a buffer to reassure the broker that an investor can repay their debt. Brokers have maintenance margins because they want to mitigate the risk of an investor defaulting on a loan.
Where have you heard about maintenance margins?
Maintenance margins are a niche subject and don’t tend to come up much in general business or economic news, so if you’re not a margin trader you may well never have heard the term.
But if you’re an investor who’s started borrowing money from a broker, you will certainly have encountered a maintenance margin, typically set at 25% of the borrowed securities' total value.
Maintenance margins are also sometimes known as ‘maintenance requirements’ or ‘minimum maintenance’.
What you need to know about maintenance margins.
Before we look in detail at maintenance margins, let’s say a few words about margin trading. Essentially, it’s the practice of buying securities with cash borrowed from your broker. Margin trading allows people and institutions to buy more shares of a company than they’d otherwise be able to afford. So, it’s an inherently speculative strategy, and you could potentially make a lot of money. But you should also be very clear about the risks. The high degree of leverage means that if things go wrong, they go badly wrong. Only consider margin trading if you’re fully aware of these risks.
Margin agreements and margin accounts
So, what do the mechanics of margin trading look like? Investors who want to start margin trading have to open what’s called a margin account. And before a margin account can be opened, the brokerage firm must obtain the investor’s signature on a margin agreement. This agreement needs to adhere to the regulatory requirements governing margin trading in your country, but each brokerage will have its own interest rate and repayment terms and conditions.
Once the margin agreement has been signed, the investor has to meet a minimum margin before trading can begin on the account. In the United States, this initial margin is at least $2,000 (£1,515) in cash or securities. Another stipulation by the US Federal Reserve Board is that investors can only borrow a maximum of 50% of the price of the security being purchased. This hasn’t always been the case – in the 1920s, for example, leverage rates of up to 90% debt weren’t uncommon.
So,what is maintenance margin? Well, once the margin trader has bought a security, the maintenance margin is imposed to protect the money loaned out by the broker on an ongoing basis. Margin requirementscan vary considerably, but in the US the Financial Industry Regulatory Authority (FINRA) demands that at least 25% of the securities’ market value is held in the account at all times. Some brokerages require more than this – their own maintenance margin will be set out in the margin agreement.
Let’s imagine you’ve opened a margin account with your brokerage firm to enable you to buy £20,000 of stock in Omnicorp. The maintenance margin is 25%, so you’re obliged to keep £5,000 in your margin account if the stock’s value remains at £20,000. But suppose Omnicorp’s share price starts climbing dramatically, and the stock you bought is now valued at £30,000. Well, in that case you’d have to keep £7,500 in your margin account to satisfy the margin requirement. That shows the maintenance margin’s impact. It works like a safety net for the broker.
If an investor allows the equity in their account to drop below the maintenance margin, the broker will issue what’s known as a margin call. This requires the investor to bring the margin account back into line – either by depositing funds, offering additional collateral or liquidating some of the securities. Brokers also have the right to sell the securities in a margin account, even without asking the investor, so that the maintenance margin can be restored.
Note that because security prices can fall, and the maintenance margin is a percentage of value, the maintenance margin isn’t a fixed amount. But maintenance margins tend to be lower than the initial margin requirement, so that the security’s price can move against the margin without forcing a margin call immediately after the initial transaction.
On instruments deemed to be particularly risky, regulators, exchanges or brokers sometimes set the maintenance requirement higher than normal – or equal to the initial requirement – to cut their exposure to the risk taken on by the trader. For speculative futures, for example, futures commission merchants may charge a premium to exchange requirements, which can be an additional 10%-25%.
If a margin call occurs unexpectedly, it can trigger a domino effect of selling that leads to ever more margin calls. One famous example of this was the ‘Bunker Hunt Day’ silver market crash on March 27, 1980. Situations like this most often occur because of an adverse change in the market value of the leveraged asset or contract. They can also happen when the margin requirement is raised – for example, because of greater volatility.
Remember, as well as protecting brokers against the risk that a margin trader will default on a loan, there’s a very good systemic reason for margin requirementsand all the regulatory oversight of margin trading. Investors who participate in margin trading have the potential to make huge losses as well as colossal gains. If such losses are left unsupervised, a snowball effect of losses could disrupt the entire financial market. And that would be in nobody’s interests.
Find out more about maintenance margins.
If you’d like to explore ‘what is maintenance margin’ further, why not take a look at some other related definitions in our comprehensive online glossary? We define broker, equity, margin and many other terms you’ll encounter as you start investing.
For an in-depth explanation of the regulatory demands on margin traders in the US, the Financial Industry Regulatory Authority’s website sets out all the rules very clearly. Just follow this link for an overview of US margin requirements. In the UK, the Financial Conduct Authority sets the regulations.
Lots of books have been written about margin trading, and you might want to take a look at one or two if you’re seriously interested in the subject. ‘Margin Trading from A to Z’ by Michael T. Curley offers a step-by-step explanation of the mechanics of the margin account. The book sets out to show how a margin call is arrived at; how it can be answered; and how an account looks once a call is issued and after the call is met. Here’s a link to the book on Amazon.
Another book on the subject is ‘Margin Trading: Your Step-by-Step Guide to Margin Trading’ by Patrick Patterson. In eight chapters, the book explains what is margin trading, how to maintain a margin account, and what the margin requirements are. Follow this link to take a look.