When an investor or trader wishes to borrow money from a brokerage firm in order to trade securities, they will need to set up a margin account. When purchasing securities on margin, the margin account protects the brokerage against loss. According to the rules of the Financial Industry Regulatory Authority (FINRA) twenty-five percent of the value of securities in a margin account must be covered by a margin. However, many brokerages require more, up to as high as forty percent. If a trader sustains significant losses, he or she may need to replenish the account and will be a “margin call” notification from the broker. Here is the maintenance margin explained.
Maintenance Margin Meaning
When trading stocks, options, currencies, or futures, traders use margin to leverage their trading capital. The rationale is that a few percent of interest per year on borrowed money will be a minor expense when compared to the gains expected from a well-chosen and managed trade. A ten percent gain in a stock price can potentially be multiplied by borrowing most of the money and coming up with only a small portion out of pocket. A margin account makes this possible.
Maintenance Margin Formula
The amount of money in a margin account will depend on how much you will need to borrow in order to trade and the margin percentage used. FINRA sets the minimum at 25% although your brokerage may require a higher percentage. Using the FINRA 25% requirement the amount of money maintained in your margin account must be equal to or more than a fourth of the value of what you owe the brokerage for stocks you have purchased using their money. Margin account =or> 25% x stocks purchased on margin.
How to Calculate Maintenance Margin
As a practical matter your brokerage will automatically calculate your maintenance margin for you and will reliably let you know when you need to replenish your margin account. The risk every trader needs to be aware of is that of getting a margin call because a trade or investment went badly. As such a wise trader will be constantly aware of how much they are trading on market and will trade in ways to remain well within the limits of their account by using hedging strategies or simply keeping their trading amounts well within the capacity of their margin account.
Maintenance Margin vs Variation Margin
Maintenance margin and variation margin mean the same thing. When you set a margin account you will typically put enough money into the account to cover a margin-based trade you are making plus enough extra to cover reasonable value fluctuations. The point of calling a maintenance margin a variation margin is that the required amount will vary with the price of the stock or other equity purchased on margin. If the trade does well the account will be sufficient and if the trades goes badly a trader may receive a margin call and have to replenish the account. If they are not able to do so the brokerage will sell the equity to cover any of its losses.
Initial Margin vs Maintenance Margin
The initial margin is what you will generally set up to make your first trade or to prepare for margin trading. The maintenance margin is what you will need to maintain in the account. If your trading amounts are well within the limits of the account and your trades are generally successful, your initial margin may always be greater than or equal to your maintenance margin.
Maintenance Margin Example
Although FINRA requires a 25% margin, your brokerage may require 30% so we will use 30% for our maintenance margin example. If you have $20,000 in stocks on margin you will need to have $6,000 in your margin account. If you increase that amount to $30,000 you will need to increase your margin account to $9,000. If the market value of your equities falls, the margin requirement remains the same. Thus, if your stocks on market fall beneath the maintenance margin you will need to add money to the margin account to cover a margin call.
Overnight Maintenance Margin
When trading futures an initial margin which is also called an overnight margin needs to be set for either a buy or sell side position. This overnight maintenance margin allows the trader to carry a position past the exchange’s daily close. Traders must have a trading account balance sufficient to cover any initial margin. Details about handling margin accounts in futures trading is part of what a day trader learns from DayTradeSafe along with how to effectively open, manage, and close profitable trades.