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Margin Call: Summary
Margin Call - Definition
Margin Call is a notification from your broker to top up cash into your margin account so that it is once again at initial margin level.
Margin Call - Introduction
Margin call is definitely the most dreadful term in futures trading. It is the nightmare of all futures traders because what margin call is telling you is that you have lost money, probably a lot of it and is now required to provide even more money. In fact, some futures traders live in fear of margin calls so much that every phone call or email scares them so much they get sleepless nights.
So, what is this margin call all about and why is it so frightening? Is there any way to avoid margin calls?
What is Margin Call in Futures Trading?
Have you ever bought a futures contract in the morning on a hot tip from a CTA and then by the end of the day your futures broker calls you up demanding that you deposit more money into your account because that position has taken a bad drop?
That is a margin call.
A margin call is a "friendly" call or email notification you receive from your futures broker at the end of a trading day asking you to deposit more money into your account when your margin balance (account balance) drops below the maintenance margin level. If you fail to do so, a part of or all of your position will be forcefully offset by the broker. Yes, its like rubbing salt to your wound when you have already taken a big loss for the day. That's why Margin Calls have always been the nightmare of futures traders. Margin calls tell you that you have not only taken a loss on your position for the day but is now required to deposit even more money just to keep the position alive!
Purpose of Margin Call
The purpose of margin calls is to lower the risk of default faced by the clearinghouse's having to guarantee the performance of every futures contract in order to ensure a liquid and healthy futures market. If futures traders are allowed to go into deep losses without margin calls, losses might accumulate so much as to become unservicable by the futures trader. Hence a margin call not only protects the exchange but the futures traders as well.
Margin calls also serve to remind futures traders who are too busy to keep a constant tab on their positions that a position is losing money and its probably best to take a look at it now to determine if it is still worth keeping. If it is no longer worth upkeeping, they can simply allow the position to be forcefully offsetted without taking further risks.
When Are Margin Calls Issued?
Margin Calls are issued whenever your margin balance drops below the required "Maintenance Margin" level of the position you are in. This is sometimes also known as "Minimum Margin Level", indicating the minimum amount of cash you need in your account in order to keep the position running.
When a new futures position is created, initial margin is deposited as required. Daily profits will be added to and loses taken from this margin balance during daily settlement. If losses accumulate enough to bring the margin balance below the "Maintenance Margin" requirement, a margin call will be triggered after daily settlement.
Margin calls do not always happen only during the end of a trading day in futures trading during daily settlement. Sometimes, when the price of the underlying asset unexpectedly crashes intraday, the futures trading exchange may assess the risk high enough to justify an "Intraday Margin Call" on the longs to top up to initial margin before the end of the trading day or trading period. Intraday Margin Calls are not common and are done to prevent margin accounts from going down all the way to zero or negative in a single day or within a few hours due to unexpected price crashes.